Looking at risk boundaries

04 February 2015

Patrick Norwood – Insight Analyst for Funds

Most of you will have already seen our 2015 Diamond Ratings, launched on 1 February. One of the fund ‘universes’ comprises families of funds that are either risk targeted or risk focused.

Risk targeted fund families

A risk targeted fund family contains a set of multi-asset funds, usually managed by the same team and following the same investment process across the family. It will explicitly target risk in the funds' objectives, with risk and return targets increasing across the family.

The targets for each fund will almost always be ranges of volatility – the standard deviation of the fund’s price.

This means that the manager will have to reduce a fund’s exposure to riskier assets, such as overseas equities, and increase the allocation to less risky assets, such as cash and government bonds, if the upper volatility band is reached and vice versa if the fund’s volatility approaches the lower band. The manager could also change some of the underlying funds to less/more risky ones within each fund’s portfolio in order to reduce/increase risk.

Risk focused fund families

A risk focused fund family in Defaqto's population also contains multi-asset funds. These are marketed together; the managers of each individual fund, if not the same, will come from the same team; and the process, if not the same across the family/range, will be similar, for example using the same investment philosophy. Also, these families are such that the funds in the family can be ordered in terms of increasing risk and return.

The big difference between these funds and risk targeted is that they do not explicitly target risk. They will, however, be bound by risk in some way, having a limit on the amount the fund can hold in equities through the IMA sector it sits in, for example.

Determining how important risk and return targets are

Whether the adviser or client should choose risk targeted or risk focused funds depends on how much importance they attach to risk.

If maintaining risk within their desired range is very important to them and returns more secondary, then risk targeted funds are probably best.

If, however, the adviser or client would like a fund with some return target, and risk control is slightly less important, then risk focused funds might be better.

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