Ratings agency Fundhouse is looking at overhauling the way it labels funds, moving towards a metric based on potential returns instead of downside risk in an effort to stop investors “putting the cart before the horse”.
The plan by Fundhouse, which is currently being tested with clients, is motivated by the aim of preventing “underinvested” clients from missing financial goals, and bids to shift away from what the firm sees as excessive risk aversion among investors.
“There are no return ratings out there – it’s just risk ratings,” co-founder Rory Maguire said. “You are taking a client who is risk-averse and telling them more and more about the risks – but the risk is they miss their return goals.”
The system would involve five ratings for portfolios, with return levels such as ‘cash plus 2 per cent’, while risk would be graded partly through the use of client time horizons.
“Time horizon matters – broadly, cash plus 5 per cent is [a return objective for] someone who needs more than five years’ time horizon,” Mr Maguire added.
The attempt to change the ratings system comes at a time when concerns are mounting over both assets traditionally perceived as ‘safe’ and individuals who are still opting for cash over investments. The idea has proved popular among some advisers, according to Fundhouse.
However, some fund buyers are critical of the move, with a number raising concerns about the plans. Rowan Dartington Signature technical investment director Guy Stephens said the change could be “dangerous” for client outcomes.
“While I can see why this has been created, it could be dangerous,” he said. “Focusing on return without also referencing risk could result in more risk being taken to achieve an aim without the investor understanding this.”
Others questioned the simplicity of swapping risk for return goals.
Mick Gilligan, a partner at Killik & Co, described them as “two sides of the same coin”, but claimed switching the primary focus to returns could lessen a fund buyer’s control.
“Whether you start with one or the other doesn’t matter,” he said. “But you have more certainty over risk than over returns.”
Mr Maguire acknowledged returns would be difficult to gauge, but said clients taking too cautious an approach over long-term horizons was a greater concern.
“What clients need is a return matched to long-term goals, then to discuss the risk of getting there. By placing risk first, it’s cart before the horse,” he said.
“We know we are risk-averse by nature, so it should not surprise us that we overdo the emphasis on risk – the outcomes are exactly what we would expect from a species riddled with anxiety and risk aversion. But, that’s not to say we back a mindset of high risk/return at all costs.”
Some buyers have been more welcoming to the idea, but elevated valuations have also focused minds on risk.
“We are very happy with a fund ratings agency looking at a return basis,” said Peter Lowman, chief investment officer at wealth manager Investment Quorum.