Matching a fund to the risk profile of a client 

This article is part of
Guide to picking a fund

Matching a fund to the risk profile of a client 

Picking the right fund is a complex process, and at the start there are many factors to take into account.

According to Darius McDermott, managing director of Chelsea Financial Services this can be a combination of the individual needs of a client, the necessity of diversification, and the relevance of the wider macroeconomic environment, making it far from straightforward.

He says: “But when you strip away a lot of the noise it generally boils down to three things, namely their investment timeframe; their risk vs. return profile (how much loss can they stomach to achieve their long-term investment goals); and whether they need growth or an income from their investments.

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"Age and investable assets often fall into these three areas and form the central pillars of risk profiling.”

What does the client want to achieve?

This point was elaborated on by Gary Potter, who jointly runs a range of multi-manager funds at BMO Asset Management said the first consideration for a fund picker is the question of what the client wants to achieve.

He says once this is established, the job of the adviser is then to decide at what pace they want to achieve the goal.

Mr Potter says: “You could go at 30mph and get there, it will take longer but there is very little risk that you don’t make it.

"The alternative is to go at, say 80mph, and the likelihood is that the goal will be achieved much more quickly, though the risk of it going wrong and the goal not being achieved is also higher.

"If you are looking at which of those approaches to take, then clients' starting point, including their age, their time horizon and their capacity for loss are then the considerations. 

"More equity in a client's portfolio probably means more risk, while more bonds would traditionally mean less risk.”

Volatility vs risk

Alex Farlow, head of risk-based solutions at consultancy firm Square Mile Research, says that while the market generally tends to focus on how volatile an investment is, this misunderstands that the relevant risk for the client is that they fail to hit their investment objective.

He says the first consideration should be the maximum loss of capital that could occur in a fund in bad times, and the extent to which each client is in a position to handle this risk.

He adds that volatility is defined as the propensity for the price of an investment to move sharply up or down in price, but that this is not the same as risk. Mr Farlow said this is the key to aligning the interests of the client with those of the fund chosen.

As FTAdviser has previously reported, many market participants highlight that a key problem with the Mifid rules is they do treat volatility in the same way as they treat risk.