Potential risk ‘must not be overlooked’

Risk-rated products, be they multi-asset funds, multi-manager funds or model portfolios have become increasingly sought after in recent years, with new products being launched and existing funds looking to get themselves risk rated.

The move to risk-rated funds, according to Jason Hollands, managing director of business development and communications at Bestinvest, was started by the TCF (treating customers fairly) requirements, then exacerbated by the RDR and the insistence that advisers use a more robust investment selection process.

But it’s possible that in sparking this flood to risk-rated funds, the regulator has created a whole new set of problems.

“People have become a bit obsessed with risk-rated funds. I worry that they look at the risk rating and not at what the fund has done and what it is trying to do,” says Ben Yearsley, head of investment research at Charles Stanley Direct.

Andrew Merricks, head of investments at Skerritt Consultants, compares the possible problems to those that were inherent in the old managed funds that people used to invest in without doing their homework on them properly.

“There is definitely the potential for an accident to occur with risk rating. It has the potential to be like the cautious managed sector in 2008, which still got hammered even though it was supposed to be low risk.”

To start with, the problem is what risk-rated product you choose. You can go with a multi-manager approach, such as the popular Jupiter Merlin range that recently had its funds risk-rated.

A slightly cheaper option would be a multi-asset fund, which is directly invested so misses out the extra layer of fund fees from a multi-manager.

There are also more model portfolio services cropping up, many from discretionary fund managers (DFMs), but others from providers such as Morningstar OBSR, which are all risk-rated in some way.

This range of products and risk-rated tools leads to an added problem of whether the tool used to risk rate the product is trustworthy, although the regulator has admitted that significant improvements have been made in that area by external risk-rating providers since its preliminary investigation a couple of years ago.

For Mr Merricks, what advisers need to do if they want to use a risk-rated product is to put themselves into the client’s shoes and then “look at the fund you are recommending and see if the mix in that fund fits what you think you should be doing”.

Simon Webster, managing director of Facts and Figures, insists there is no problem with advisers using risk-rated funds, as long as they embark on the same level of due diligence as for all other products.

“Advisers should be looking at the same investment fundamentals as they would look at with any other funds – finding the appropriate market sector, the appropriate diversification within the sector, a track record that is appropriate, how long the fund manager has been managing it, the status of the overall fund provider.”

With risk-rated products now encompassing a wide range of offerings, from multi-asset funds to model portfolios, advisers can sometimes find it hard to compare like for like.

A further problem is there are many different risk-rating tools, both external and internal. Most risk-rated products tend to use Distribution Technology or FinaMetrica, but when it comes to using a provider’s internal risk-rating tools, the adviser must ensure they are suitable for the client.

Dan Clayden, director of Clayden Associates, says it is “very difficult” to compare risk-rated offerings because they all do “slightly different things”.

He said: “Looking at a performance measure over a period of time would be the best way to compare them, as well as taking into account other factors such as volatility and charges.”

Unfortunately, few of these risk-rated ranges have a substantial track record because they are relatively new. But advisers can still compare what they can when it comes to performance, as well as looking at the underlying fundamentals.

There is nothing inherently wrong with investing in a risk-rated model, it’s just that it is a little more open to abuse or possible shoehorning or mis-selling problems because it as seen as so simple and its use is becoming so widespread.

Yet the range of different risk-rated products means advisers need to take a lot of care when recommending them to a client, then monitoring them to ensure they remain suitable.

Matthew Jeynes is senior news reporter at Investment Adviser