Assessing risk-targeted fund families


    The number of advisers using psychometric testing to help quantify a client’s attitude to risk has increased.

    The test is a client questionnaire about their feelings regarding a range of aspects of investing. Each answer is scored and the combined figure is then measured against a risk ruler from, simply, no risk to very high risk.

    This attitude to risk questionnaire helps the adviser and their client view risk, in the same way.

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    The next step would be to work out a client’s capacity for loss, which could be the probability of a maximum capital drawdown over a investment period or it could be the failure of meeting an expected return.

    Both form part of the client discovery process and together with soft facts, collected by the adviser, form the start of a process which leads to a recommendation of an investment solution. Of course, the solution needs to be suitable for the client, in terms of their needs and expectations.

    Developing risk-targeted investment solutions

    Importantly, this process can help clients understand that to meet some goals, an acceptance of an appropriate level of risk may be necessary. So how does an adviser get from determining an understanding of a client’s risk tolerances to an investment solution?

    Volatility is the most used measure of risk in the investment world. There is no question, it is helpful to use it as a common language for both investment manufacturers and consumers.

    A client, guided by their adviser, has the ability to determine a risk budget to give to an investment professional to spend on constructing a portfolio of different asset classes. In other words, the portfolio should always maintain a risk level that either a client would not be comfortable breaching or happy to maintain.

    Of course, during periodic client reviews, an adviser would establish whether a client’s risk tolerance has remained the same. Changes in circumstances or attitude to risk could have an impact on investment requirements. It is also the adviser’s responsibility to ensure the investment solution is performing as mandated, that means it is performing within stated risk bands.

    The number of investment providers offering this type of risk-targeted solution has increased over the past few years because their appeal to clients who focus on maintaining a risk level during their investment time horizon rather than adopting a return focused approach.

    Prior to the financial crisis, investments that focused on or targeted risk were primarily associated with older investors, those seeking to reduce risk as they were approaching retirement and whose tolerance for loss was diminishing.

    With the lessons that have been learned in recent years, it is fair to say that many more investors – across a much broader demographic – now place at least equal emphasis, if not more, on managing risk as they do on maximising returns.