The Financial Investment Plan Module is a tool that can be used by investment firms to determine what investment service and investment profile are suitable for its clients. The Financial Investment Plan questionnaire can be answered by the prospect/client online or can be completed together with the asset manager or advisor. For ease of reading, below is often referred to the term 'prospect', but the tool can of course also be used for existing clients of the investment firm. If the term ‘he’ is used in this article, the reader should read this like ‘he or she’.

If the investment firm has a license agreement with Blanco for the Financial Investment Plan module, the questionnaire will be part of the prospect’s to-do list in the KYC Suite.

The questionnaire is divided into four sections:

- Financial Position (to calculate the capital available for investment)

- Investment Objective (to determine the investment goal and time horizon)

- Risk Assessment (to determine prospect’s subjective risk tolerance)

- Knowledge and Experience (to determine the prospect’s knowledge and experience)

At any time during the process of answering the questions, the prospect can return to previous answers. The tool automatically saves the entered data.

At the end of the questionnaire, a summary and a Monte Carlo simulation will be shown to the prospect.

In this chapter a description is given of the flow in case of a questionnaire for an individual account (natural person). For a joint account, the flow and questions will be mostly identical (two questions related to partner income are added). The deviations for a business account will be highlighted in paragraph 2.2.2.

The questionnaire starts with an explanation of the survey and which categorised questions can be expected. An impression is given in figure 1 below.

Figure 1 – Impression introduction page

Throughout the survey additional elaboration on the questions can be found in the right sidebar.

To learn more about the financial position of the prospect, the questionnaire starts with questions regarding the income and assets of the prospect (see figure 2).

Figure 2 – Financial Position

Below is shown which questions will be asked and if (and how) answers will be processed automatically by the software. If the information is not processed automatically by the tool, the investment firm can use this information when assessing the automatically generated proposal and adjust the proposal if necessary or desired.

After the prospect entered all details, a personal balance sheet is generated.

The free to invest capital is based on the personal balance sheet of the prospect and is calculated as investments plus savings minus short-term debts (see figure 3).

Figure 3 – Financial Position

To learn more about the financial position of the business prospect, the questionnaire starts with questions regarding income and balance sheet of the prospect (see figure 4).

Figure 4 – Financial Position Business account

Below is shown which questions can be asked (which questions are actually asked depends for a large part on the configuration of the ‘financial position’ settings, see 3.4) to business prospects and if (and how) answers will be processed automatically by the software. If the information is not processed automatically by the tool, the investment firm can use this information when assessing the automatically generated proposal and adjust the proposal if necessary or desired.

After the prospect entered all details, a balance sheet is generated.

The free to invest capital which is computed is based on the balance sheet of the prospect and is automatically calculated by using a pre-defined formula or by using the formula that was configured by the investment firm (see 3.4)

In this section of the survey, the prospect is requested to provide information about the investment goal, investment time horizon, initial deposit and recurring deposits and withdrawals.

The prospect can choose from four investment goals. Each scenario is defined by specific criteria (see figure 5).

Figure 5 – Investment objective

Income

This scenario is based on a goal which builds up assets until the prospect’s defined period of supplementary income. After the initiation of this period the system will calculate the withdrawals until the final date. The prospect is asked about the start and the end of the period of supplementary income and monthly withdrawal goals after initiation thereof.

Specific goal

This scenario is based on a lump-sum final goal. The prospect can enter the total desired amount at the end of his investment time horizon.

Safety net

This scenario is based on a lump-sum final goal. The prospect can enter the amount needed at the final date of the scenario.

General investment

In this scenario, the prospect wants to invest without a specific desired goal or amount, but with a desired return on annual investment.

Income scenario:

When the prospect chooses the ‘income-scenario’, the following questions will be asked:

Specific goal scenario:

When the prospect chooses the ‘specific goal-scenario’, the following questions will be asked:

Safety net scenario:

When the prospect chooses the ‘safety net-scenario’, the following questions will be asked:

General investment scenario:

When the prospect chooses the ‘general investment-scenario’, the following questions will be asked:

When the prospect answered all questions of this section, a summary of his time horizon, initial deposit, recurring deposits and withdrawals will be presented to the prospect in a graph (see figure 6).

Figure 6 – Overview deposits and withdrawals

In the next section of the questionnaire, the personal risk score of the prospect is determined by means of 3 questions (comparisons between scenarios) and (if activated by the investment firm) the outcome of a control question about acceptable loss.

The personal risk score is determined by letting the prospect choose between scenarios. The goal is to predetermine a prospect’s risk tolerance in such a way that it corresponds to how the prospect will actually act if a (downward) risk occurs.

Research shows that people have difficulty in estimating their risk tolerance themselves in advance (for example through qualitative questions). People appear to act differently if a risk actually occurs compared to what they estimate themselves in advance. Therefore, the best way is not to ask prospects how they see themselves, but to show “real” scenarios and see what they choose.

When investing capital, there are three factors that are necessary to fully describe a scenario (in statistical terms). These factors are presented in the most accessible way possible in the scenarios:

• Expected outcome

• Very positive result and very negative result

• Chance of a loss & chance of a profit.

See figure 7.

The questionnaire also has a control question to validate the maximum loss that a prospect can / will accept.

Figure 7 – Risk score introduction screen

The prospect’s risk score is a number from 0-100. This is extrapolated linearly from the 7-point risk meter scale (‘risicometer beleggen’, see for more information 2.4.2). Each risk score corresponds to a specific standard deviation.

The prospect is asked to answer three questions in which scenarios are compared.

For these questions, the prospect first receives a step-by-step explanation of the data in each scenario.

These are: very positive & negative result (5% and 95% percentile), chance of a loss and a profit, expected result (annual return). See figure 8.

The questions are based on 1 year, because risks are ‘felt’ in the shorter term

After all, in the longer term, profits and losses are often “spread out” / balanced out.

Figure 8 – Explanation different elements important to determine the personal risk score

The prospect is asked 3 scenario questions (see figure 9 for an example).

Each element is again briefly described when the prospect is moving his mouse over it (also called “tool tips” or “hoovering”).

Figure 9 – Example scenario question.

After the three scenario comparisons, there is one last control question about the maximum loss the prospect is willing to accept once every 20 years. This is an additional safeguard for determining the right risk score.

Based on the answers of the prospect, a personal risk score is determined and shown to the prospect (see figure 10)

Figure 10 – Risk score on a scale of 1 to 100.

The 7-point scale of the ‘Risicometer Beleggen’ has been extrapolated linearly to a score of 0-100, as conversations with customers showed that a risk score between 0-100 was more intuitive for them then the 7-point scale. This ‘translation’ into a 0-100 scale has no further impact.

Figure 11 – ‘Risicometer Beleggen’

Each risk score has a standard deviation (SD) equal to the comparable score in the ‘Risicometer Beleggen’ (in accordance with VBA / NVB).

The expected 1-year return is then determined on the basis of a risk-return formula.

To get to this risk-return formula, the 15-year historical returns and standard deviations of a representative (mutual) fund universe were collected. The risk-return formula should capture systematic market risk in a diversified portfolio, not idiosyncratic risk. Therefore, the fund universe should only include broadly diversified funds. If the fund represents only a small niche market, the observed risk is not so much the systematic market risk, but the idiosyncratic risk for that specific industry, sector or region. Therefore, the fund universe is selected based on the following criteria:

- Fund invests in one of the three largest economies in the world (EU, US, China);

- Fund invests in a broad range of sectors and markets;

- Fund has a history of at least 15 year.

This selection resulted in a fund universe of 55 funds. For all 55 funds, the 15-year Total Return Annualised (Daily) and Standard Deviation Yearly (Mo-End) were collected in Bloomberg.

As the upper limit of the risk captured in the AFM Risicometer and in the risk tolerance scenario’s is a standard deviation of 25% (risk score equal to 100), we excluded outlying funds with a standard deviation exceeding 25%. This means we had to exclude one of the 55 funds from the set.

Second, as the intercept of the function can be quite precisely determined using information from another source, we fixed the value of the intercept. Fixing the intercept also stabilises the estimated function, giving more precise estimates of returns for funds with low risk. We set the intercept of the function to the 15-year average interest on Dutch saving accounts, which was collected from the DNB website (Source: https://www.dnb.nl/statistieken/data-zoeken/#/details/deposito-s-en-leningen-van-mfi-s-aan-huishoudens-rentepercentages-gecorrigeerd-voor-breuken-maand/dataset/efba2d4e-fb53-49a8-a1fe-d5ee3263e14c/resource/8d3ccc86-8396-43b8-a18b-5ba293f01c1d). This resulted in an intercept of 0.36%.

Finally, we estimated the quadratic function using weighted least squares, with the variance of residuals of the unweighted least squares (OLS) regression as weights (see Appendix B for details). We used weighted least squares because the variance of residuals increases in risk (i.e., the dispersion of funds’ returns or scatter around the regression line increases in risk, see Figure 1 and Figure 2 below). The consequence of using weighted least squares is that more precise points (those corresponding to lower risk scores) get a larger weight in determining the estimated function, which typically results in a more stable estimated function.

Applying the procedure resulted in function Y = 0.0036 + 0.7017 X - 1.39 X2, with Y denoting the estimated fund’s return and X denoting the fund’s risk (standard deviation). Explained variance of the function was equal to .3424.

Figure 12 – visualisation of risk return function

Figure 13 – excerpt of the parameters that correspond to different risk scores

With a Monte Carlo simulation, the required statistical characteristics are then determined for each risk score:

- Very positive / negative result (5% and 95% percentile)

- Chance of profit and chance of loss

- Expected outcome

Each scenario shown to the prospect corresponds to a risk score (see the decision tree below – figure 14). The risk score can then be determined by means of a "smart" comparison of scenarios.

Figure 14 – Decision tree

The comparisons shown are each time based on previous choices made by the prospect. The prospect’s choices determine how the decision tree is traversed.

The scenarios in the comparison are at least 20 points apart, so that the prospect can see a clear difference. The risk scores increase in steps of 5 and have a confidence interval.

A client may choose any of the two scenario’s or select “no preference”. Choosing “no preference” can have two reasons:

• A prospect wants a risk that lies between the two scenarios shown

• A prospect does not understand the question

Suppose the prospect chooses “no preference” in the first question, then there are two choices that would lead to “no risk score” (NA: not applicable). First, if the prospect again chooses “no preference”, this is considered illogical, since the average of the risk scores of the two scenarios ((50 + 80 / 2) = 65) is comparable to the highest risk score in the 1st equation. So the prospect did have a preference in the first question (for the higher risk). If the prospect chooses 80 in the second question, this is not logical for the same reason: in the first question the customer would logically have already chosen 65. The client is then shown a message to contact his advisor.

The final section of the survey will determine the prospect’s knowledge and experience.

The following questions are asked:

The answers to these questions are solely meant to inform the investment firm; the answers are not processed by the Financial Investment Plan and they are not automatically included when determining the profile of the prospect.

After submitting the last question, the prospect is presented with a 4-page investment proposal.

Page 1 – Summary details

The first page summarises all answers which are relevant for the proposal: the investment goal, the percentage of capital available for investment and the personal financial balance sheet (see figure 15).

Figure 15 – Page 1 Investment Proposal

Page 2 – Investment profile

On the second page the prospect is presented with an investment profile. Each profile includes an information icon, that informs the prospect about the specific profile – a link to an information page can be added. This page also shows the probability of achieving the investment goal (see figure 16).

The investment profiles are the investment firm’s portfolios with risk scores that are calculated by using the ‘Risicometer Beleggen’ parameters and the expected returns for each portfolio.

Figure 16 – Page 2 Investment Proposal

Page 3 – Monte Carlo

The third page shows a Monte Carlo scenario analysis based on the prospect’s investment and investment time horizon, combined with past performance of the selected investment profile as added in the settings by the investment firm (see figure 17).

At this point, the prospect is able to adjust some answers, such as his investment goal (amount), the initial investment, the deposits and withdrawals and the time horizon.

Figure 17 – Page 3 Investment Proposal

If the prospect indicated that not achieving the final goal has little to no negative effect on his future lifestyle in the ‘Investment Objective’ section, and he selected a profile that will not reach the minimum desired chance of achieving his goal in the section ‘Investment Objective’ as well, the prospect will be warned. In case the prospect indicated that not achieving his final goal has a negative or a very big negative effect on his future lifestyle, he will not only be warned but he is also required to confirm that he wants to continue with a low-chance scenario if he does not change the parameters.

If allowed by the investment firm (by means of the settings) the prospect can chose to deviate from the selected profile to a more defensive or offensive risk score. If the prospect deviates from the proposed profile, another explanatory screen will show the changes. The prospect is required to confirm the change or if he will maintain the proposed profile.

Page 4 – Agreement of proposal

On the last page of the investment proposal the prospect is required to either agree to the proposal or to further discuss it with the investment firm (see figure 18).

Figure 18 – Page 4 Investment Proposal

After the prospect submitted the survey, the tool will automatically generate a PDF file for the investment firm. The investment firm can then further process the questionnaire, discuss the outcome with the prospect and/or determine a final investment profile for the prospect.

In the general settings (see figure 19), the investment firm can generate e-mail templates that will be used when sending an email to the prospect. Different texts can be drafted for natural persons and business accounts. The investment firm can also indicate here whether the financial investment plan questionnaire is part of the to-do list in the prospect portal (do-it-yourself) or if the prospect needs to fill in the questionnaire together with an employee of the investment firm. Also, a referral page can be added, to which the prospect will be directed after finishing the questionnaire.

Figure 19 – General settings

In the section ‘remediation’ (see figure 20), the investment firm can configure automatically triggered remediation. If this function is activated, the system will periodically (the applicable interval can be configured in months) generate a new financial investment plan to be filled out by the client. If this happens, the investment firm gets a notification after which the email, with the pre-defined invitation to start the review of the financial investment plan, can be sent to the client. The button ‘allow professional user to skip remediation’ gives the investment firm the option to skip an automatically triggered remediation for a specific client if desired.

Figure 20 – Remediation

In the section ‘profiles’ (see figures 21 and 22), the investment firm is able to add and edit its own investment profiles. These are the profiles shown to the prospect in the investment proposal, see for example figure 16. The following configuration can be done:

- Profile-name;

- Profile description;

- Risk scores (see 2.4.1, these scores can be determined by using the conversion sheet provided by Blanco);

- Net return;

- Standard deviation;

- Asset Allocation;

o Option to show asset allocation in investment proposal

o Description asset category

o Weight

- Benchmark;

o Option to show benchmark in investment proposal

o Description benchmark

Figure 21 – Profiles

Figure 22 – Profiles

The investment firm is able to allow the prospect to manually change the proposed profile in the investment proposal to another profile by enabling this setting. Through adjusting the settings, the investment firm is able to allow the prospect to switch to a more defensive or offensive profile, and to set a maximum negative and positive deviation or limit the change to the personal risk score of the prospect whenever the risk needed to achieve the investment goal is lower than the personal risk score of the prospect.

Figure 23 – Profile settings

With settings as shown in Figure 23, the prospect is allowed to deviate 10 points both positive and negative from his original risk score as determined in the risk assessment as described in 2.4.1. If for example the prospect has a risk score of 65, and he is proposed profile ‘The Brave’ (risk score 60), it is possible to switch to profile ‘The Gambler’ (risk score 75).

Here the investment firm can make changes to the financial position section of the questionnaire. The investment firm can indicate whether he would like to ask the question about accrued pension yes/no, he can make changes to the balance sheet of a business registration (see figure 24) and make changes to the income statement of a business registration.

Figure 24 – Financial position settings

For every investment scenario, the investment firm can choose from various settings such as the minimum and maximum horizon, and the minimum chance threshold (see figure 25).

Figure 25 – Investment goals settings

The minimum chance threshold determines the minimum percentage the prospect can use as an answer to the question ‘What is your expectation, percentage wise, of achieving your goal at the end of the investment horizon?’. To protect the prospect, the investment firm determines the minimum chance the client can choose from.

The risk score of the prospect is determined on the basis of how the risk assessment questions were answered in the questionnaire (see 2.4) and the control question (if included in the risk tolerance calculation by the investment firm). This control question, and a number of other settings, can be configured by the investment firm to adjust the way the final risk score of the prospect is determined and can be found under ‘Risk assessment’. For example customisation of the engine, confidence interval, the previously mentioned control question and the layout of the scenario questions.

On the ‘engine’ tab (see figure 26) the expected outcome formula is shown. This formula is the result of the extensive regression as described in 2.4.2 and is used as input for the risk assessment questions and the control question. If desired by the investment firm, the formula can be changed after which the preview function can be used to see the effect in a graph (figure 27).

Figure 26 – Risk assessment settings (engine)

Figure 27 – Formula visualisation

After changes are approved by the investment firm, the new settings are activated after running a new simulation by use of the ‘Run simulation’ button.

On the ‘confidence interval’ tab (see figure 28) two settings can be adjusted. The confidence interval configuration makes it possible for the investment firm to influence the number of excessive outcomes that are included in the scenarios on which the risk score questionnaire questions and control question are based. The mean reversion setting is another tool to cut of the extreme returns. The theory behind this tool is that over time the returns of a portfolio return to the mean.

Figure 28 – Risk assessment settings (confidence interval)

On the ‘control’ tab (see figure 29) the investment firm has the possibility to (deactivate) the use and configurate the settings of the control question. If activated, this question is presented to the prospect after he has finished the three questions in the risk score questionnaire (see 2.4.1). Typically, the answer options in this question are filled with the risk scores and standard deviations of the respective risk profiles used by the investment firm (see 3.2).

Figure 29 – Risk assessment settings (control)

By pressing the ‘Preview question’ button, the investment firm can see what question is presented to the prospect. In case of the configuration as shown in figure 29, that would be as shown in figure 30:

Figure 30 – Preview control question

The one-year losses in the control question are based on a fictional investment amount (which can be changed by the investment firm) and calculated using the (rounded) one-year losses as shown in the ‘control question’ overview (figure 29). These one-year losses are the 5% percentile after 1 year outcome of the Monte Carlo simulation (the expected return percentages as shown in the control question overview are the 10-year average outcomes of the MC simulation, these returns are not shown to the prospect).

Example of control question effect:

If the personal risk score of the prospect after filling out the 3 questions in the risk score questionnaire is determined to be 65, this would correspond with an acceptable one-year loss of 19,58% (rounded to 20% in the control question) if configuration of the risk assessment settings resulted in the overview as shown in figure 31.

Figure 31 – control question settings

After filling out the first 3 questions, the prospect would then be presented with the control question as shown in figure 30.

If prospect would choose for one of the first 3 answers, this would result in his original risk score being overruled by his answer (and the risk score corresponding to his answer). If he for example would choose € 10.000 (-10%), his risk score would be adjusted to 50 (see figure 31).

The last setting which can be configured in the ‘Risk assessment’ section can be found under the ‘design (layout)’ tab (see figure 32) Here, the investment firm has the possibility to choose the layout which is used to present the risk assessment questions to the prospect.

Figure 32 – design (layout) options

The tool provides three settings for the Monte Carlo analyses (which results in a graph that shows the prospect the different scenario outcomes): 1) The number of runs in the simulation, 2) the results shown in the graph, and 3) the maximum chance threshold (see figure 33).

Figure 33 – Monte Carlo settings

1. The number of runs in the simulation

This setting determines the number of iterations used in the Monte Carlo analysis for a single portfolio. This is bound between 1000 and 2500 runs. The minimum is set to provide some form of stability, whereas the maximum helps to improve performance of the program as more simulations will increase load-time. A lower amount of runs will increase speed, while producing less precise lines.

2. The results shown in the graph

While performing a Monte Carlo analysis, runs with very extreme outcomes may occur that have a large effect on the representation of the graph. For example, an extremely positive scenario could lead the highest line to be moved up significantly for just one simulation. Therefore, we have decided to visualise a subset of the simulations (however, this can also be turned off to show all possible scenarios). By tweaking this setting, the percentage of simulations that are visualised is determined.

3. The maximum chance threshold

The selection of a profile is a complex process of which this threshold is an important part. This threshold depicts the probability of success that a portfolio needs to attain in order to be suitable for the end-client. By default, the risk score determines the chosen portfolio, but if less risky portfolios already provide a probability of success that is equal to or higher than this threshold, this will be recommended instead.

Suppose a prospect with a risk score of 85.

Available portfolios for this prospect are:

· Portfolio ‘5’, risk score: 74, chance to achieve the investment goal with this portfolio: 90%

· Portfolio ‘6’, risk score 83, chance to achieve the investment goal with this portfolio: 95%

If the ‘maximum chance threshold’ is set at 90%, then the tool automatically selects the portfolio ‘5’ being the best suitable. The reasoning is that Portfolio ‘5’ would result in achieving the desired investment goal with the lowest possible risk.

This function can be bypassed when the setting is set at 100%.

Flags (‘warning’) can be created for financial position and risk assessment answers. The investment firm can determine himself when he would like to get a warning, for example when the savings of a client are below a certain amount in the financial position section, or whenever the outcome of the scenario questions in the risk assessment section differs from the outcome of the control question.

Figure 34 – Flag creator