A lack of clarity about how model portfolios are risk rated could mean advisers and clients end up choosing inappropriate investments.
Research seen by Money Marketing shows a significant disparity in ratings on products with the same label.
Analysis of more than 500 model portfolios carried out by risk profiling service Dynamic Planner exposes how different the asset allocation and strategies of portfolios with the same description can be. It reviewed some 540 model portfolios used by advisers, comparing their labelling and stated risk rating.
Among growth portfolios the median risk score was six, but the risk ratings for the group varied from two right up to 10 at the top of the scale; a significant variance for a group of investment portfolios with the same overall objective.
Income portfolios vary from a maxi-mum profile of seven to a minimum of two around their median of five.
Dynamic Planner proposition director Chris Jones says: “There is this anomaly where the name of a fund or portfolio doesn’t have anything to do with its risk level. When you see it in black and white, you realise how striking this disparity can be.”
The major concern in this is that advisers and their clients could end up investing in unsuitable portfolios because they have been labelled in a way that does not reflect their underlying asset allocation.
Of the portfolios analysed that had a risk rating of two, the maximum allocation to emerging markets equities was just 1 per cent. Meanwhile, portfolios rated a 10 on the risk spectrum had up to 62 per cent of their assets in emerging markets equities.
Portfolios rated a two typically had 52.8 per cent of their assets in cash, while no portfolios with a 10 rating held any cash. It means the strategies and therefore outcomes of growth portfolios, which may have a risk profile of anything from two to 10, are entirely different.
This significant variation in risk profile is not just evident in growth and income portfolios either. The risk ratings on balanced portfolios ranged from three to six on the Dynamic Planner risk scale.
Defaqto insight consultant Fraser Donaldson says: “I don’t think this vagueness is anything new. If you compare cautious portfolios A and B, they can be wildly different.”
FCA moots action
A key issue is that while risk metrics have evolved, they still have many subjective elements. One investor’s balanced may be another person’s aggressive, and the danger of trying to firm up the definitions too much is that they become excessively narrow.