As the trend for advisers outsourcing the individual asset allocation for clients and investing in multi-asset solutions has grown, so has the demand for funds that are managed to align to different risk levels. For many clients success is not just about the greatest return from the investment, it is about achieving the optimal return while also taking the level of risk that they can afford.
The closest that the conventional IMA sectors come to grouping together funds taking different levels of risk is in the three mixed investment fund sectors. The zero per cent to 35 per cent shares limits the equity exposure to 35 per cent and in which a minimum of 45 per cent must be held in investment grade fixed income and cash. The 20 per cent to 60 per cent shares limits the equity exposure to the levels stated and also has a minimum requirement of 30 per cent fixed income and cash.
At the higher end is the mixed investment 40 per cent to 85 per cent sector with no minimum fixed income or cash requirement. Even although these are broad bands, they constrain investment managers to operate within asset class limits. Another factor that makes IMA sectors difficult to use for risk-targeted funds is that their sectors contain funds managed to a range of different objectives and for which risk management is not necessarily the prime focus. Therefore, although the IMA sectors succeed in grouping together funds with broadly similar asset allocation, comparison remains difficult due to the range of different objectives.
So how can the adviser select a fund if the conventional IMA sectors do not provide the answer?
The first step is to identify how the output from the risk profile process used by the adviser aligns or maps into the various risk-targeted funds available. As part of their investment process, advisers may well use one of the risk-profile questionnaires whose output, when considered along with factors such as capacity for loss will produce an indication of the appropriate risk level for the client. The risk-profile tools such as Distribution Technology’s Dynamic Planner or Finametrica provide the link between the attitude to risk obtained through their questionnaire and the risk level of funds whose risk they have reviewed.
However, it is important to note that a large number of funds with a risk rating are not actively risk-managed. The rating companies assess the asset allocation of the funds at a point in time and, based on that analysis, the funds are given a risk rating. In many cases the funds are not being actively managed for risk, and their subsequent risk rating comes entirely from the snapshot of their asset allocation. It is not unusual to see funds such as strategic bond funds sitting in a risk category alongside risk-targeted multi-asset funds – similar risk levels at a point in time but with very different strategies and approach to risk management.
For the adviser seeking a risk-targeted fund to form most, or all of a client’s portfolio, the analysis has to be much deeper than a simple selection from a list of funds that have been allocated a similar risk rating.
A good source of information on risk-targeted funds is the Defaqto Risk-Targeted Fund study 2013. This study identified all of the risk-targeted fund ranges on the market and then assessed them against a range of criteria.
Choice characteristics
If an adviser is using risk-targeted funds across its client base, then the fund range has to demonstrate a number of characteristics in addition to pure investment performance:
• Breadth:
Is the range sufficiently broad to ensure that the temptation to shoehorn clients into a limited number is avoided? I would suggest that four funds managed to different risk levels should be a minimum, but more would be preferable.
• Activity of risk management:
Some risk-targeted funds sit in broadly constant asset allocations whereas others are more actively managed with their risk budget deployed where the managers believe they can best add value for the investor.
• Risk corridor or risk limited?:
Most of the funds within the risk-targeted sector operate within a risk band with upper or lower limits. However, some operate below the upper risk limit and adopt an approach of taking risk off the table where they feel it prudent to do so.
• Conformity to a pattern:
Does the range of funds conform to the pattern that might be expected in relation to their risk vs return? This includes the performance target of the funds becoming progressively higher as the client takes greater levels of risk.
• Consistent behaviour:
Do the funds behave in a consistent manner across the range? If there is a range of four or five funds, are they managed to clearly different risk levels and, where risk is being managed, is this done across the range?
• Fit with adviser’s proposition:
An adviser may well use multi-asset funds for a large portion, or indeed all, of the client’s portfolio. In using a multi-asset fund as a solution for a client’s portfolio the adviser still retains responsibility for reviewing the performance of the investment manager, ensuring that the investment remains suitable for the client and that the client is kept adequately informed about their investments. It is therefore extremely important for an adviser to be well informed and up-to-date regarding the investment manager’s actions and views. How well the investment manager communicates with the adviser and the extent to which support is provided by the investment manager in terms of briefing, reporting and other communication can be important factors in assisting the adviser in his relationship with the client.
Steps for advisers
So what steps should an adviser take when looking to select a fund that is managed to align with the level of risk that they have identified for their client?
• Identify the population of fund ranges in the market – perhaps using a study such as Defaqto.
• Ensure that the characteristics of the fund range fit the needs of the firm – breadth to avoid shoehorning, consistency of approach, quality of reporting and communication.
• Ensure that the fund range identified is aligned to, or can be mapped to the firm’s preferred risk profile and approach.
• Ensure that the approach adopted by the investment manager is clear, transparent and fits with the approach of the firm.
Unfortunately, having identified your shortlist of funds there is not yet a sector or index that can provide an easy comparison for all risk tools. Advisers currently have to turn to the tried and tested approaches - comparing the historical performance using market tools such as Trustnet, Financial Express and others until such time as an appropriate sector or index is developed and introduced to the market.
John Jackson is managing director of Intermediary Business of Cornelian Asset Managers
Key points
Advisers typically look beyond conventional IMA sectors when trying to match a suitable multi-asset fund with their client’s specific level of risk
The closest that the conventional IMA sectors come to grouping together funds taking different levels of risk is in the three mixed investment fund sectors.
A large number of funds with a risk rating are not actively risk-managed.
