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By Simona Stankovska | Published Jul 30, 2012

Does risk tally with reward?

“No pain, no gain” is a cliché that applies in finance as well as in life. Nevertheless, in what has been an unpredictable and turbulent 12 months for global stockmarkets, Investment Adviser research shows that in spite of stomaching a relatively high level of pain, funds in the IMA UK All Companies sector have not delivered greater gains for their investors.

It is a commonly held view that in order to generate greater returns, investors have to take on more risks. But over the short term, this is not necessarily the case.

According to data provider Morningstar, the UK All Companies sector took on more risk than four of the five other IMA UK peer groups – UK Equity Income, UK Equity and Bond Income, UK Gilts and UK Index-Linked Gilts – in the six months to July 30. But it only managed to generate a return that was 0.53 percentage points greater than, for example, the IMA UK Gilts sector, which took a quarter of the risk.

Morningstar assesses risk based on volatility or the annualised standard deviation of a fund’s returns over 36 months. Based on this calculation, in the first six months of 2012 the IMA UK All Companies sector’s average risk was 4.7 – relatively high compared with government bonds. Meanwhile, the sector’s return in that period was 0.76 per cent.

Although volatility measures only short-term risks – or swings in the market – the figures show that on certain measures, taking what is perceived to be greater risk is still not paying off for investors.

The riskiest fund, the Standard Life Investments UK Equity Recovery fund, only managed to return 0.65 per cent – less than the sector average – but took more than double the risk at 10.08. Conversely, the Allianz UK Unconstrained fund – which took the lowest risk at 3.16 per cent – generated a return of 1.17 per cent in the first six months of 2012.

The CF Eden UK Select Opportunities, which was the best performing UK All Companies fund in the six months to June 29 2012, with a return of 1.85 per cent, took risk of only 5.63 – not vastly more than the sector.

Eden Financial fund manager Leigh Himsworth says he pays little or no attention to the index, claiming that the FTSE All-Share, which the fund is benchmarked against, has “massive stock-specific skews”. He recently told Investment Adviser: “The top five stocks make up 50 per cent of the index and, actually, most investors don’t know the risk they take on with an index fund. I want to create a portfolio that is aware of risk and controls risk.”

There were also funds that were less volatile and failed to generate a positive return. The Manek Growth fund recorded an average monthly loss of 1.84 per cent but had a standard deviation of 3.26. The fund experienced outflows of more than £800,000 in the first five months of this year.

Balancing risk and reward

Ben Seager-Scott, senior analyst at Bestinvest, sums it up: “Taking on more risk doesn’t automatically mean you get more reward. It’s rather a case of, in order to get higher growth potential, investors generally need to take on a higher level of risk. Certainly we have seen this to be the case historically, with assets such as equities outperforming lower risk assets such as high-quality, corporate bonds in the long term – 10 or 20 years.”

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