Risk-rated funds ‘do not remove due diligence burden’
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Defaqto has warned advisers not to view risk-targeted portfolios as a way of avoiding the burden of carrying out robust due diligence.
The financial research company said although the assets under management of risk-targeted funds “remain small” the offerings are expected to “grow significantly” in the coming years.
Risk-targeted funds, which are offered by some discretionary managers, aim to ensure that each fund stays within pre-set parameters with respect to their risks, such as volatility or maxiumum drawdown.
The popularity of such funds is expected to grow as advisers continue to outsource their investment management duties to third parties ahead of the implementation of the RDR.
Adrian Gaspar, senior consultant at Defaqto, said that while well run and successful risk-targeted funds meet “several requirements” of advisers keen to outsource, there is still an onus on them to make sure the product is suitable for their clients.
“While these funds are effectively an outsourced solution it does not remove the burden of due diligence and ongoing servicing from advisers, as a detailed assessment of each provider and fund range will still need to be completed and reviewed periodically,” he said.
“The increasing number of passive or predominantly passive risk targeted funds being launched also helps provide potentially more cost effective solutions. But again the adviser will still need to understand the proposition, whether asset allocation differs significantly from an alternative active fund and whether the fund managers are managing their tracking errors effectively against each benchmark [or the degree to which fund portfolios diverge from their benchmark index].”
Mr Gaspar added the FSA had provided “several reminders” that no funds or ranges of funds should be treated as a “one cap fits all” solution.
He added adviser firms that use risk-targeted fund ranges must also be aware that these are different to multi-manager or multi-asset funds which have been given a risk rating by a third party.
“To confuse matters further, fund groups now also need to display a synthetic risk and reward indicator (SRRI) on a key investor information document (Kiid) for all Ucits funds,” Mr Gaspar said.
“An issue for advisers is that SRRI ratings have their own seven fixed volatility bands based on historic unit prices over five years, or synthetic performance if the funds do not have a long enough track record, whereas some risk targeted fund ranges may be designed based on expected volatility outcomes over future 10-year time horizons.
“This difference in approach will generate anomalies in outcomes and it will be important that providers of risk targeted funds explain clearly how the two fit together and what the different outcomes reflect.”