When it comes to multi-asset funds, including products that pertain to being ‘cautious’ or use numeric risk-labelling systems, the question of how to monitor and communicate investment risk is now central.
In 2011 the FSA issued a criticism of the tools which are often used to rate multi-asset funds’ risk profiles.
The regulator said: “Nine out of the 11 tools we reviewed had features that meant that there was a high probability that, under certain circumstances, the output might not accurately reflect the risk a customer is willing or able to take.”
The FSA has not revealed which tools failed in spite of demands. The providers themselves are not permitted to disclose whether they passed or failed the regulator’s assessment. So, how are advisers supposed to choose?
Australian risk profiling specialist Finametrica has published a list of 20 questions it recommends advisers ask when faced with a risk profiling tool or a fund which has been rated. Although Finametrica admits its own vested interest in the subject, its questions are likely to be useful if advisers are unsure whether to trust the number assigned to a fund.
Finametrica recommends advisers enquire about aspects such as experience in dealing with the adviser market, how the reliability of the rating has been established, and whether it allows for “inconsistent” answers to be dealt with rather than ignored.
However, even if you are convinced by the quality of a risk-profiling tool there are problems when looking at the results in isolation.
Chief among these concerns was that most funds’ ratings were clustered around the top end of the 1-7 scale regardless of their asset class and track record.
This meant that, for example, Investec’s £2bn Emerging Markets Local Currency Debt fund has the same risk rating – five out of seven – as the Invesco Perpetual Monthly Income Plus fund, in spite of the many fundamental differences between the two funds’ investment processes and universes.
On the surface there appears to be a similar issue with risk profiling. Distribution Technology, for example, rates more than 330 funds – many of them multi-asset funds – and discretionary portfolios from 49 fund management clients on its scale of 1-10.
Of these products, 80 per cent sit in categories ‘3’, ‘4’, ‘5’ and ‘6’. No funds are yet rated ‘9’, the second highest risk level, and only one – Octopus’s cash fund – is rated ‘1’.
Within the ‘8’ rating, Distribution Technology’s methodology has placed the Swip Multi-Manager UK Equity Income fund – which splits its mandate between four managers – alongside Aviva Investors’ Multi Asset V fund, which invests mainly in tracker funds.
Shelley Robertson, marketing manager at Distribution Technology, told Investment Adviser that the high concentration of funds in the middle ratings reflected the general distribution of funds. Few funds are rated ‘1’ because it is supposed to indicate cash investments, while ‘9’ and ‘10’ reflect the most aggressive strategies.
Nick Reeve is senior reporter at Investment Adviser
