Same goals, different solutions

But in spite of the flurry of activity and launches in this particular space and even with the new regulatory requirements firmly bedded in, the very people they were aimed at are yet to be entirely convinced by their respective unique selling points.

Arguably they have caused much confusion among both financial advisers and end investors, as while the two investment styles may sound similar in name, they operate in very different ways.

Differences

Risk-rated funds are assessed, typically independently, and based on their asset mix and historical data are given a rating or score, usually between one and 10 depending on how risky the portfolio is – the higher the score the punchier the fund.

This rating will in theory provide an adviser with a guide to whether it is appropriate for their client. An investor with an average attitude to risk would, for example, typically suit a portfolio with a ‘five’ rating.

On the other hand risk-targeted funds aim to control risk usually by a measure of volatility. The idea is that the fund strictly operates within set parameters and even when markets in general endure both bull and bear phases, the risk profile of a risk-targeted fund should remain pretty steady.

What the two styles have in common is that they aim to help advisers provide investment solutions that meet their clients’ attitudes to risks. But intermediaries believe matching risk attitudes to numbers can be something of a blunt and simplistic tool.

Criticism

Critics of risk-targeted funds assert that just because a fund is rated, say, a ‘five’, it usually has no explicit goal to maintain this rating – the rating does not mean it will stick to the number over time, as markets change and evolve.

For instance, a fund rated ‘three’ could become a ‘four’ or even a ‘five’ on the risk scale as markets move and asset allocation alters. Meanwhile, detractors of risk-targeted vehicles say the approach is too rigid, as they cannot deviate from their set levels of volatility.

Gavin Haynes, managing director at Whitechurch Securities, believes that in reality the uncertain and ever changing nature of investment markets can make it difficult for both types of funds.

He says: “I am not an advocate of using volatility to dictate your investment approach and while giving a fund a rating is useful, it should only be used as a guide. The adviser should have a knowledge of how this rating is achieved and ensure that the product provider’s risk profile is aligned with their client’s.”

Laith Khalaf, senior analyst at Hargreaves Lansdown, believes the approach is arguably too unscientific. He says: “We do not use risk rating as a measure or benchmark. Instead, we prefer to make our own judgment calls in terms of the quality of the fund and the risk it is taking. We believe reducing risk to a single number can be misleading.”

Mr Haynes adds: “Overall I do believe that risk-targeted and risk-rated investment solutions have an important part to play. However, they should not be seen as an easy option and advisers need to do their due diligence to ensure they are being employed correctly.”

Philip Scott is a freelance journalist

Expert view: ‘Untested’ vehicles

Laith Khalaf, senior analyst at Hargreaves Lansdown, highlights that given both risk-rated and risk-targeted funds are a relatively new phenomenon, they still remain somewhat untested. He warns: “They have not been through the mill yet.”.