Psychometrics is defined as studying the theory and technique of educational and psychological measurement, which includes the measurement of knowledge, abilities, attitudes, and personality traits. More simply, psychometrics is the psychological theory or technique of mental measurement.

 

In the context of wealth management, psychometrics basically means making clients undergo psychological tests to assess their risk appetite and reaction to large gains or losses to help guide investment advice.

 

In recent years, psychologists, bankers and academics have been attempting to find uses for psychometrics in the area of wealth management. To a certain extent they have succeeded.

 

Even before the global crisis, psychometrics was used to measure the risk profile of investment clients. Usually this is done by interviews or questionnaires when the client purchases an investment fund.

 

The global crisis has however demonstrated that the existing ways of risk profiling are not adequate. In Hong Kong, for example, the scandal over the Lehman mini-bonds demonstrates this. In this case, Lehman mini-bond buyers claim they were not told about the risky nature of the product. For example, regulators now require banks and investment advisors to closely monitor the risk profile of their clients. The challenge for banks is that there is presently no common standard or method for measuring an investors’ risk profile.

 

Barclays, which acquired Lehman’s North American unit following its collapse in September 2008, has been playing around with psychometrics in a bid to help their wealth management clients better define their investment objectives and requirements, determine their risk profile, and achieve their investment objectives.

 

Designed by Greg Davies, an MPhil in economics and a PhD in behavioural decision theory from Cambridge University, Barclays Wealth (the wealth management  unit of Barclays) started work on its psychometrics model in 2006. It has been used in the UK and Europe for the past two years. It was rolled out to  US clients in July and in Dubai the week of 14 September. On 25 September, it was rolled out in Hong Kong and Singapore.

 

It has been tested on 3,000-4,000 of Barclays Wealth’s global wealth management clients so far. Before that, it was tested on 5,000-6,000 experimental clients. Eventually, Barclays Wealth hopes to use it for 80% of all its wealth management clients, the total number of which the bank declined to disclose, according to Davies. “Clients worldwide are asking pretty tough questions. Psychometrics puts back the humanity into investing. This may also be useful for regulatory and compliance purposes.”

 

Barclays Wealth's psychometrics involves having a wealth management client fill up an 8-page financial personality questionnaire with a total of 56 questions covering two areas: financial personality and investment objectives. The financial personality aspect is intended to be a behavioural description of the client and his/her attitude towards his/her entire wealth.

 

The objective of the questionnaire is to provide the client and Barclays Wealth information that will be used for providing feedback on the client’s financial personality and its implications on his/her investment decision making. Based on this information and feedback, Barclays Wealth will then recommend an optimized investment portfolio that is tailored for a particular client’s needs and requirements. 

 

The difference between the Barclays Wealth's psychometric approach and similar methods of risk profiling used by other banks is that it “provides guidance on the best portfolio structure given individual circumstance,” according to Davies, who also heads Barclays behavioural finance team.

 

For example, a case study presented by Davies identifies Mr. Li (fictitious) whose psychometric profile is: average in risk tolerance, low in composure, higher than average in market engagement, very high in perceived financial expertise, average in delegation, and average in his belief in personal skills. Based on this financial personality profile, the proposed asset allocation for Mr. Li’s portfolio would be 75% market return and 25% absolute return, says Davies.

 

The success of the psychometric model in investment profiling depends a lot on how forthcoming the participating clients are with their personal experience, preference and other information. “The more accurately you represent yourself in the questionnaire, the more satisfied you are likely to be with the performance of your investments,” Davies says. In Asia, wealth management clients have traditionally been more reticent that their overseas counterparts when disclosing such information.