Cedric Bucher, head of business development at Architas, on why clients' attitude to risk must be closely monitored.
There has been a surge in interest and launches of risk-profiled funds lately, and not without good reason. Markets have been experiencing heightened volatility since the 2008 crisis, and many investors have seen the value of their investments swing seemingly uncontrollably.
This has driven a shift in investors’ primary concern from expected return to expected risk: they are becoming much more aware of the bumpiness of their investment journey as well as the size of the pot they can expect to receive at the end. More and more investors and their advisers are taking advantage of risk-profiled funds as a way of controlling the amount of volatility they experience.
Modern Portfolio Theory tells us that a diversified portfolio of assets is likely to experience less drastic swings in value than a single asset class by itself and this may go some way to explaining why the popularity of multi-asset investment solutions has been rising over the past decade.
Are you regularly reviewing client risk profiles?
Recent volatility and the emphasis on transparency demanded by the imminent Retail Distribution Review have encouraged the FSA to introduce stricter guidelines surrounding client investment suitability; this has been another key contributor to the increased prominence of risk-profiled funds.
As advisers and investors alike clamour for risk-profiled funds, not only are more funds now risk-profiled, but more risk-profiling tools are coming to the market. The first stage of all risk-profiling, however, is universal: to establish a client’s attitude to risk – their tolerance for fluctuations in the value of their investments and their capacity to absorb investment losses. Once a client’s risk profile has been established, the universe of potential investments is restricted considerably to those whose profile matches the client’s.
When it comes to risk-profiling funds, there are two distinct approaches: a fund house can either manage a fund to a specific target risk profile, or they can retrospectively map the fund to a profile. In the case of the former, it will be the primary objective of the fund house to ensure that the risk of the fund remains within a specific risk profile by monitoring changes in the risk-return characteristics of each asset class, and adjusting their asset allocation accordingly.
An optimal asset allocation model will be devised for each risk profile. It will combine assets in such a way that the overall volatility of the portfolio will remain within the target boundaries for that profile, while the expected return for that level of risk is maximised.
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