Lately it seems not a day goes by without a ‘new’ multi-asset offering being available to investors. Some of these funds are genuinely new and some are just rebrands of existing products, nevertheless the enthusiasm for this asset class seems boundless. Most of this activity has been accompanied by a new trend for the risk rating of these funds so that advisers can try to assess the potential risk level of these products.
However, despite similar risk ratings being awarded to these funds, they can actually be very different to one another. Advisers need to be aware of these differences and what they mean otherwise it could lead to some unpleasant surprises.
Since the publication of the FSA Assessing Suitability paper, risk profiling of clients and products has become a key focus for advisers. The paper talks about how important it is that a firm ensures that its clients’ investment portfolios match the risk profiles, generated by any risk-profiling tool that advisers may use.
Therefore, if a client is deemed to have a low tolerance or capacity for risk, their investment portfolio must be low risk. The firm also has to show a clear audit trail of how they arrived at these conclusions and prove the investment portfolio is low risk, as well as ensuring the process is repeatable across its whole client base.
Such work from the FSA is leading the way globally in protecting clients by looking at such matters.
Many advisers have already taken this on board and are working hard to ensure their process is robust enough to stand regulatory scrutiny. This action from the FSA has led to product providers moving to fill the gap with a solution. Fund houses have realised that from now on they need to demonstrate the risk level of their products to advisers and how these products fit within different client risk levels.
Therefore we have seen a spate of new launches and fund rebrands to fit within this new regulatory framework. However, many of these funds may not be what they seem. I believe a pattern is emerging for two different types of risk rating multi-asset funds.
First, there are those that are specifically designed to target a volatility level in line with an explicit risk profile. For these funds, it is embedded within their investment process to meet this volatility target by altering their asset allocation to ensure they maintain a consistent and predictable volatility level, while also generating good returns.
The second type are those that have been ‘retro-risk rated’. These products are usually legacy multi-asset funds with an established investment process, typically focused on a performance target rather than a risk target.
As most current risk-profiling methodologies are mainly historic, these two kinds of funds may appear to have similar levels of volatility. This type of risk rating is no more than a snapshot of a fund’s volatility and is not an indicator of future volatility. For the first type of funds - those funds that have been designed to achieve a defined volatility target - their risk rating should provide a reasonable indicator of future volatility.