The challenge of comparing risk-targeted funds

While the mixed investment sectors in the IMA universe have evolved to create peer groups of broadly similar funds, the development of risk-targeted sectors within the IMA universe is not currently on the horizon.

Consequently, the ability to compare like-for-like funds – as far as a risk target is concerned – is limited for investors. One way is to look at tables from risk-rating firms such as Distribution Technology and FinaMetrica and see which funds are rated, say, a ‘five’ or a ‘four’ and then compare performance from there.

Alternatively, Financial Express (FE) has its own risk-targeted multi-asset solutions sectors, split into risk bands ranging from ‘one’ to ‘five’, and an additional sector for those funds that would fall into a category but have yet to build up a long enough track record.

The potential issue with this option, of course, is that it is based on a risk score given by FE Analytics, so advisers and clients would need to know how this tallied with their own risk metrics before looking any further at the sectors.

On a broad view, however, this is a strong first step towards making these funds comparable for investors, with the three-year average performance of the five risk sectors following the expected trend of the highest risk band delivering the highest average return of 34.54 per cent and the lowest risk band, ‘one’, producing the lowest average return of 14.86 per cent.

The 12-month performance figures, however, do highlight a potential issue with these types of funds, with the FE UK RTMA Risk Band 3, which has an FE risk score of 50-70, actually producing an average return of 5.45 per cent, which just outperformed the higher risk band ‘four’ with a return of 5.35 per cent.

This begs the question: why is the sector average of medium-risk targeted funds outperforming the theoretically higher-risk funds in the past 12 months? Is it a single outlier fund? Is it the macroeconomic environment? Or are there other causes?

While performance figures do not reveal everything, they do provide an insight and a starting point from which to delve further. In this case, it shows that while these funds may be classed at specific risk targets, that is far from the whole story.

Nyree Stewart is features editor at Investment Adviser

Key facts

• Financial Express has launched five risk-targeted multi-asset solution sectors, as well as one for those funds that do not have a long enough track record

• For the three years to August 18 2014 the five risk-targeted sectors all performed in line with expectations – the higher the risk band the higher returns

• There are approximately 32 funds listed in the FE UK RTMA Risk Band 1 category

• In the FE UK RTMA Risk Band 5 category there are roughly 16 listed funds