The EU Financial Instruments Directive (MiFID II) that is due to come into force next year requires that financial advisors acquire a risk profile of their client when making investment decisions for them. It’s a legislation that is attempting to fill in some of the gaps in the industry, especially in the light of crowd based platforms that provide limited profiling of users.
Many of the tests currently on the market take the form of verbal questionnaires that examine things like the financial knowledge of the investor and a self-assessment of their willingness to take risks. Whilst better than nothing, such tests often provide an incomplete assessment of the investor, especially as few of these tests are based upon the latest scientific thinking.
Investor profiling
It’s into this context that French startup Neuroprofiler steps. The company, who recently graduated from Accenture’s Fintech Innovation Lab, take a gamified approach to assess the profile of each investor.
The games, which are MiFID compliant, come in a short and long form, guide investors through a series of choices that contrast two distinct risk/reward options. Each option is displayed in a graphic format that is designed to make it easy to understand the potential for gains or losses in each scenario, even for novice investors. The aim is that the choices reflect real-life investment scenarios, and therefore provide an accurate profile of the investor.
Each investor is evaluated across three dimensions:
- appetite for gains
- loss aversion
- optimism
The game deploys a Bayesian predictive model to assess each choice made, before then presenting additional options that are uniquely crafted based upon previous answers. By taking such an approach, the company believe they can develop a rich profile relatively quickly.
What’s more, by adopting a quick and effective way of measuring ones investment style, it’s a test that can be performed multiple times to take account of our changing circumstances.
Cues from Kahneman
The approach borrows heavily from the work of Nobel Prize winner Daniel Kahneman, and in particular his work around prospect theory, which underlines why so many of us make such bad, and seemingly irrational, financial decisions.
The theory details a range of cognitive biases that undermine our decision making processes, and the biases are built into the assessments undertaken by Neuroprofiler.
Whilst Kahneman’s work is certainly far from unknown, it has been very slowly adopted in the financial world. His theories are certainly viable now however, not least because we have access to much more data, and AI has made analyzing it easier and more effective. As such, companies such as Neuroprofiler have been able to take the theory from the lab to the marketplace.
The system is currently being tested at French bank BPCE, and the hope is that this will eventually be rolled out in more financial companies in the coming year.
“What our suitability testing solution offers to financial services firms is not only more relevant risk profile results, it is also a better customer experience, easier, more fun and more educational ? with, not to forget, better compliance with the KYC requirements imposed by MiFID. We know that major financial institutions are eager to experiment with FinTech solutions. We make it easy for them to adopt our solution by providing an integration API,” the company say.
