Suitability of risk-rated, targeted and managed funds

This can be found in the FSA paper issued in the summer of 2012 on replacement business and Cips: Assessing suitability: Replacement business and centralised investment propositions FSA, July 2012.

She says: “Most firms already understand that assessing clients attitude to risk/capacity for risk is simply the trigger to discuss the desired financial goals clearly, so there is clarity about the amount of risk the customer is comfortable with and the investment implications.

“The appropriateness of the fund for each client must be considered in relation to their specific objectives.

“If a solution is not suitable for an individual client, a firm should recommend an alternative suitable solution or make no recommendation to the client.

“Where a firm has a diverse client bank, it may wish to consider segmenting its clients. This allows them to offer a range of solutions which best meet the needs and objectives of different client segments.”

Careful and comprehensive dialogue between a financial adviser and client are essential to determine how much risk a client is capable and willing to assume, says Anthony Gillham, portfolio manager of the Old Mutual Voyager Strategic Bond fund.

Mr Gilham says financial advisers will often submit a questionnaire to help determine the risk parameters of the investor. A fund that targets the specific risk level determined to be right for a given customer is the one most likely to meet their needs, he adds.

He says: “Advisers should always ask why a manager’s risk managed solution is likely to exhibit consistent risk characteristics in the future, a problem that risk targeted funds are designed to solve.”

Patrick Connolly, Certified Financial Planner at Chase de Vere, says it is a challenge to make sure the right funds are recommended to the right client and there is no shortcut with risk-rated, risk-targeted and risk-managed funds.

He says a full fact find process must be completed together with an appropriate attitude to risk questionnaire and discussion so that the adviser and their client agree on the correct level of risk to be taken and, importantly, the client’s capacity for investment loss.

Mr Connolly says: “Extensive research needs to be undertaken on the funds themselves examining the manager and team, the processes they use, the controls and limitations they have in place and the evidence that the fund is able to perform as it says ‘on the tin’.

“It would be a mistake to assume these funds are a panacea or even the best solution. For most investors they aren’t although they should at least provide some form of safety net to ensure that the investor doesn’t go too far wrong.”

Advisers need to understand the underlying asset allocation of funds, says Martin Bamford, Chartered Financial Planner and managing director at Informed Choice, as this is what drives the risk being taken.

Mr Bamford says if he was considering a risk-rated fund, he would want to know how it was invested and then undertake independent analysis of the asset allocation, to satisfy himself it was a fund taking the level of risk he expects it to take.

He says: “Advisers should also understand the parameters set by the fund manager, so they know how the fund might be altered in different market conditions.”

Old Mutual’s Mr Gillham says advisers should ask why a manager’s risk managed solution is likely to exhibit consistent risk characteristics in the future. He says risk-targeted funds aim to do just this.

Mr Gilham says: “Advisers should further satisfy themselves that the manager has sufficiently broad and deep resources as well as enough experience to deliver on these solutions.”