In particular the FCA, in the guise of the FSA, raised concerns in March 2011 about how advisers establish clients’ risk tolerance, noting that risk tools can produce flawed results.

However, the use of risk ratings has been further boosted by the requirement of a synthetic risk reward indicator (SRRI) in a fund’s key investor information document (Kiid).

Iain McLeod, multi-asset investment specialist at Standard Life Investments, notes the SRRI is “now sort of an industry-standard risk rating for all Ucits funds” as they have to publish a number using a prescribed methodology.

But he adds that having a risk rating does not mean the fund has a risk-managed objective.

Bruce Moss, strategy director of eValue FE, a data provider, suggests the funds have become popular as they appear an easy and efficient way of meeting the regulator’s guidance. “All the adviser has to do is to get the client to answer a risk-profile questionnaire, discuss the results and recommend a risk-rated fund matching the client’s profile. The fund is then expected to be managed so that it remains in line with this risk profile. There are, unfortunately, many serious problems with risk-rated funds.”

He says the regulator expects an adviser to consider existing investments when reviewing a portfolio, so they can’t recommend a risk-rated portfolio without looking at existing assets.

“The FCA has made it clear it is very concerned that the use of risk-rated funds may lead to ‘churning’ – recommending the sale of good investments simply to match the client’s risk profile with a risk-rated fund.”

The main providers of risk-rating and risk-profiling solutions and services are Value FE, FinaMetrica, Barrie & Hibbert and Distribution Technology, although each has their own processes. FinaMetrica provides risk profiling, not risk ratings, while Distribution Technology focuses on rating funds, mainly multi-asset, multi-manager and model portfolios.

Ben Willis, investment manager and head of research at Whitechurch Securities, adds: “More and more advisers are using independent risk profilers to ascertain client risk. If you can then match the risk profile to a risk-rated fund of the same level, this offers an efficient, clearly auditable, suitable and simple method of servicing the client’s investment needs.”

Mr McLeod highlights another option offered by some firms, including SLI and Skandia – a range of funds targeting a specific risk band – arguing a risk rating can be relied on too much.

“A risk rating, which could be the SRRI or a rating given by any number of companies that look at a fund’s historic portfolio or price performance, is one point in time. It is a reflection of what that fund has done, and it doesn’t mean that is what the fund will do in the future.”

John Ventre, head of multi-manager at Old Mutual Global Investors, which runs the Spectrum range of risk-targeted funds, agrees that while an adviser might regularly review a client’s risk tolerance there is no guarantee a risk-rated fund will stay at the same level.

“There is an ongoing monitoring point that is important here. The adviser has the responsibility not only to ensure the fund is suitable for the customer but that it stays suitable.

“Their obligations aren’t on a one-off basis, and with a risk-targeted fund that makes it easier for them, as they don’t have to be constantly wondering if the fund’s risk rating will stay at the level.”

Phil Morse, director of asset management clients at Distribution Technology, says the firm has risk-rated roughly 600 funds, and expects that figure to potentially rise to 1,000 by the end of 2013.

But he points out: “We’re not saying the risk-rated fund is a good one – just that it matches attitude to risk. We review the funds on a quarterly basis. There will always be some movement, so we keep an eye on it.

“For example a risk-rated 5 fund we would expect to sometimes be a 4 or a 6, but if it stays a 6 for a period of time, we would speak to the fund group to see if they are changing the way the fund is run.”

Patrick Ingram, head of corporate relationships at Parmenion, points out while understanding risk tolerance is becoming more important, there is no common risk framework in the industry.

“A good first step is determining what risk framework and then getting into the detail of how an individual fund or portfolio fits into that structure. There are different methodologies for lining up funds and/or portfolios that help an adviser pick the right one for the client.”

Nyree Stewart is deputy features editor at Investment Adviser