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The use of risk-based asset allocation investment strategies to select funds may prove harmful to investor returns, senior fund managers have warned.
‘I perceive the logic of it all: the regulator doesn’t want bad outcomes; IFAs don’t want to be sued,’ said John Chatfeild-Roberts, head of Jupiter Merlin Fund of Funds at Jupiter.
Speaking at a roundtable discussion held by Cofunds in London today, the manager said Jupiter did not have a risk mapping tool, but planned to use one. ‘So we will go to the least bad solution for the providers,’ he added. ‘But what about the poor old client?’
The comments came amid mounting efforts to match funds with investors’ risk profiles: last week, fund supermarket Fidelity FundsNetwork launched a risk-based portfolio proposition to rival Standard Life's MyFolio and Skandia's Spectrum.
‘I’m sure we’ll all be using risk-based tools – but whether that’s the best outcome for investors, I have my doubts,’ said Chatfeild-Roberts.
Garry Potter, co-head of Multi Manager at Thames River, warned at the same event that prevailing ideas about risk may push people towards asset classes that are likely to perform badly over the long-term.
‘My concern is that you’ve got to take some risk to make some return, to beat the CPI or RPI,’ he said. ‘Ultimately we are encouraging a nation of savers to be very negative on anything that might make them a bit of money over 10 years.’
Potter noted, however, that he was ‘very sympathetic’ towards platforms that enable advisers to have ‘a much more intelligent discussion’ about clients’ expectations of future income and needs – but said it should only form ‘the basis’ of a discussion.
‘I’m afraid that rear-view mirror investing doesn’t work,’ he continued.
According to Bill McQuaker, head of multi manager at Henderson, there are appropriate investment strategies for investors who cannot countenance suffering any losses. Yet he added that these were unlikely to meet the needs of most people who want to secure an income that will beat inflation, and enough cash for emergencies.
To meet these requirements in the medium term and ‘map’ them on to markets, an appropriate strategy would involve quite a high equity content and probably not much exposure to government bonds, he said.
‘It’s a real strategy for real people; whereas this process that has been devised by the regulators is a real strategy for real lawyers,’ McQuaker continued.
Later in the discussion, Chatfeild-Roberts stressed the importance of how advisers go about risk-profiling their clients.
‘If the question is, “Do you mind losing 10%?” of course nobody actually wants to give up 10%,’ he said. ‘But if it’s framed, “If you thought your income stream was going to run at 5% for the next ten years, but in the interim your capital values were going to do this",' he said, waving his arm up and down, 'it probably wouldn’t sound quite so bad.’
Comments (7)
Have to say that for all the good intentions, I agree with John C-R et al. Its all well and good having a belt and braces approach, but do the trousers actually fit?
14:31 on 22 February 2012
Well the sooner the FSA/FCA stop regulating and criticising with the full benefit of hindsight the better it will be for everyone, including the general public. What is needed is an industry standard risk scoring system which can be used to indicate the expected level of risk and volatility for different funds with a standard risk explanation but as there seems little chance the regulator will assist with such a task and just wants to criticise and condemn at a future date, I suspect we're all doomed to the whims of Hector, Margaret and co.
14:33 on 22 February 2012
@Jonnie, haven’t you just proposed what the article is criticising?
Oh and Margaret has left the FSA and Hector is going to the PRA…
14:46 on 22 February 2012
Interesting to see Gary Potter negative on Risk tools and yet uses them exclusively for his Lifestyle range of funds
14:52 on 22 February 2012
The point is missed, as usual. One can risk-rate any fund by its historic volatility. This is as pointless as ranking funds by past performance. Managing a portfolio within a prescribed volatility range is very different, and I suspect none of the contributors have ever had to do it. Since it is difficult to do, I expect they would rather not, hence the focus on chasing returns, with varying results. Successfully managing within a volatility constraint (as Skandia has with its Spectrum range) provides customers with the outcome led solutions they seek. If managers were more prepared to accept some risk themselves (eg for underperformance) then I would take objections to managing volatility more seriously. But since they won't, I won't.
15:21 on 22 February 2012
First point: Risk is subjective
Second point: Risk changes continually both from a 'perception' and 'reality' point of view, with these generally opposing each other.
For example, in the period from August 2007 to March 2009 UK equities fell by approximately 54%...
The perception was that the 'risk' of equity investment was increasing, the reality was that the risk of equity investing was decreasing... there MUST be less risk in buying an asset class of 46% of it's previous value as one simply cannot suffer the initial 54% loss.
So, the risk of loss by investment in each asset class changes continually and thus measuring the historic volatility of any fund, particularly multi asset funds is about as much use as a chocolate teapot.
The use of any such measure would have to assume that the manager (who of course may change) will continue to manage the fund in exactly the same way against the backdrop of exactly the same economic and emotioal factors, something that is most unlikely to happen.
With the exception of a few "volatility/risk driven funds" (such as Skandia's Spectrum range) risk rating funds is therefore futile.
It is possible, however, to construct portfolios (and funds) where returns are driven by targetting volatility/risk.
This requires constant regular reviews of economics, fiscal/monetary policy and asset class volatility/correlation.
These reviews can then be used drive changes to asset allocations and combined with regular rebalancing to the new model can keep delivering returns within agreed parameters (most of the time).
Finally, clients should be free to move between asset allocations at any time so those who understand investment principals can move to allocations with higher equity content AFTER markets have suffered significant losses.
This, unfortunately, goes against what most 'advisers' recommend after large falls in equity values...
Top selling fund sector in 2009??? Cautious (whatever that means) Managed... makes no sense at all!
16:32 on 22 February 2012
There are some very good points here, and it is good to see that more people are coming around to the realisation that risk assessment is about as scientific as telling fairy stories.
The first point though is to be clear in one's terminology. You must… almost gets it right, but it must be clear we are talking about investment risk. Risk is merely the probability of something happening, and in many instances can be measured objectively. I would suggest that it is all but impossible to measure investment risk because of the multiplicity of factors that are in play at any one time.
Although we cannot realistically measure investment risk (and for Graham's sake we must make it clear that volatility is NOT a measure of risk, though it may be a function of risk, and so far as I know is historic, which makes it a weak tool to use for foretelling the future) we do then have to add individual perception of risk. As Behavioural Finance has demonstrated this is not easy. Not everyone thinks the same way, or has the same priorities. The expression of risk can vary according to question asked, or even the personality of the person asking the question.
Then we have the dichotomy expressed by Bill McQuaker, namely people want their cake and they want to eat it too.
Nevertheless the FSA are besotted with idea of managing investment risk, though they have never defined what it is. The fear of loosing money is a concept in Behavioural Finance, it is not a working and measurable definition o investment risk.
Jonnie's idea of issuing a defined chart is about the only practical way forward since it defines parameters for investment managers, advisers and consumers. In order to communicate effectively it is first necessary to speak the same language. At the present the language of investment risk is primitive. If we regularise the usage of the language, no matter how primitive it is, we will be on the first step aligning customer requirement with customer perception. Weaknesses in the language will be exposed and lead to greater understanding.
I have used such a process for over 20 years very satisfactorily. What we need is an industry wide vocabulary.
Unless that is imposed by the FSA I do not see it working because the current black hole suits investment houses extremely well. They can continue to tell different fairy stories to different clients, and no one can gainsay them. So we can have a risk-based portfolio proposition that does whatever the manager wants it to do, because it is a fairy story.
And unless the definition is imposed by the FSA clients will be free to say that they did not understand the advice given and it didn't meet their needs - when the market falls, as it invariably will.
In the meantime Investment Houses can continue to tell their fairy tales because the media love to print them, and this gives the House excellent exposure.
Guess who the fall guys will continue to be without that initial explanatory step.
20:50 on 22 February 2012
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