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Risk runners

IFAs are calling on fund companies to be clear about what risks managers are taking to achieve returns.

They have highlighted a mismatch in how risk is perceived by fund
managers, advisers and consumers.

What has clouded the issue is that fund managers are not required by
the FSA to supply standard risk descriptions of their products.

There is also a wealth of terms such as alpha, beta and volatility
for advisers to get to grips with. Alpha is performance compared with
a fund’s benchmark, beta is how much a fund will move if its
benchmark moves by 1 per cent and shows sensitivity to market changes
while volatility is the standard deviation of a fund over a given
time period.

Some firms believe that many advisers do not understand the basic
principles that make some funds naturally more risky, for example,
that a mid-cap fund will be riskier than a blue-chip fund.

But there is an impasse as IFAs want fund managers to be more clear.

The FSA seems ready to try to break the deadlock. Last week, it made
the first move in a potential overhaul of risk warnings by releasing
the results of a consumer consultation. What has become clear is that
consumers are cynical about risk warnings and pay little attention to
them. Respondents told the FSA that they place more confidence in
advisers and are prepared to go with advisers’ judgement even if risk
warnings are not understood. But what happens if advisers fail to
understand the riskiness of a fund? This is a hurdle that the FSA has
to face.

Schroders is one fund management group that has sought to tackle this
problem head-on. All year, it has been briefing advisers on key
investment strategies and giving them an insight into key terms.

Head of UK sales Neil Bridge says: “What we have been doing has been
aimed at ensuring that IFAs have all the information they need to
understand how products work. Unless they can understand the levels
of risk that an individual fund has, they are never going to be able
to give appropriate guidance to a client.”

Many specialist advisers give products their own risk ratings that
are applied consistently across all funds to ensure consumers know
precisely what they are getting.

Chelsea Financial Services managing director Darius McDermott
explains that the firm’s risk ratings are based on the type of fund
and closer examination of volatility. For example, the Merrill Lynch
UK dynamic fund has a three-year volatility of 4.4 and the Rensburgh
UK growth fund has volatility of 4.3. Both of these funds have a
similar risk rating but the performance on the Merrill Lynch fund has
been considerably better.

McDermott thinks that IFAs would be helped by fund managers taking a
standardised approach to risk ratings. He says: “It is a very
difficult task to give products risk ratings when the information you
are getting is so mixed. Fund management companies provide a certain
amount of information but it varies from company to company.

“We have been seeing more of a move towards understanding of risk
and it is a good indicator of performance. Clearly, if a fund has
performed exactly the same as another one but has done it with lower
risk, then that fund is the one you invest in.”

A move by IFAs to understand risk has been matched by efforts from
product providers to give clarity in their product definitions. A
number of funds have been relabelled because their investment
strategy and risk were not reflected in the name of the fund.

Bates Investment Services head of research James Dalby thinks
advisers have been left in a difficult position. He says: “The IFA
is in the middle, caught between the information that they get from
the fund manager and the needs of the client. There is a real
mis-match that needs realigning.

“Volatility is not an adequate indicator of risk on its own. You can
have a fund that steadily declines over time but the volatility would
be very low because it did this smoothly and yet you could lose a
considerable amount of money on it.”

Credit Suisse Asset Management says a recent survey of intermediaries
it conducted showed that they each have a separate definition of risk.

Product development manager Toby Hogbin says: “People’s perspectives
of risk are different. There is no point trying to develop some
standardised risk assessment model if it is not going to be applied
consistently. After all, a risk assessment would only be any good if
you can compare with other funds. We do not think that there would be
any point in developing a model unless there is a ruling on what is
needed. If there was, then we could look at that.”

It seems that eyes have turned to the regulator to lead the way in
this area. A risk rating must be set that the end-consumer can easily
get to grips with.

The FSA needs to set down risk ratings that force the hand of fund
managers to answer for the risks they are taking and that consumers,
IFAs and product providers can all understand.

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