Risk-profiled funds – the perils of the peer group

A notable recent trend in the industry has been the increasing use of risk-profiled fund solutions by advisers. This is understandable given the FCA’s increased focus on suitability and the fact that these solutions can provide a cost-efficient way of meeting client needs. However, because each of these products is very different in how it is constructed and the outcome it is designed to achieve – comparison is challenging.

It is, of course, the client who is paramount in the minds of advisers and designers of fund solutions and it’s imperative that the client is able to understand what to expect from any recommended product. It follows that when reviewing the performance of a solution, such a review should be carried out in the context of it is designed to achieve. In other words, is it delivering its stated outcome for investors – and therefore meeting your clients’ expectations?

Assessing fund performance – there’s a right way and a wrong way

Risk-profiled funds tend to follow a multi-asset approach, combining different asset classes in order to provide both a diversification benefit as well as offering a range of risk profiles.

Our approach is based not on the historical performance of individual asset classes, but how they tend to behave relative to each other. This means we can be confident that the portfolio will maintain the desired risk and return characteristics in the future.

While all risk based funds look to keep risk at an appropriate level, there are many different ways to achieve this. One way to ensure risk is kept at an appropriate level is to manage the fund to a long-term strategic benchmark, constructed to deliver a given level of risk over time. The methodology for constructing the strategic allocation will vary for each solution, but ideally it will be set using an in-depth analysis of the historical volatility and correlation of the different asset classes. At Fidelity, we test a large number of different scenarios for how asset classes could behave over the long term. Our approach is based not on the historical performance of individual asset classes, but how they tend to behave relative to each other. This means we can be confident that the portfolio will maintain the desired risk and return characteristics in the future.

Because managers approach this fundamental part of fund design differently, they will offer different asset mixes, potentially holding different asset classes. They will use different risk and return assumptions to underpin their modelling, resulting in different long term expectations. All in all, multi asset funds from different providers – while designed to have similar risk characteristics – may hold very different asset allocations and look very different to each other. This means that care needs to be taken when comparing funds and that makes a simple peer group analysis approach problematic.

Risk-profiled funds are often judged against funds which fall within the IMA ‘Mixed Asset’ sectors. However, the rules for the IMA Mixed Asset sectors are very flexible in terms of asset allocation. For example, one fund within the Flexible Investment sector can have an equity exposure of 100% while another could hold no equities at all. The sectors include many different funds following diverse investment approaches and asset allocation policies. In performance terms, such wide sector parameters will typically favour funds which take extreme positions. So, funds which maintain a relatively high exposure to growth-oriented assets should be expected to outperform in bull markets but underperform in bear markets. Conversely, funds which consistently maintain higher relative weightings to safer assets should be expected to outperform in bear markets but underperform in bull markets. Of course, there is nothing wrong with funds taking extreme asset allocation positions or having wide asset allocation parameters so long as the funds’ investors have understood and are happy with the risks involved.

Risk based funds, however, are designed differently – they are managed to defined client risk profiles and so will generally have much more constrained asset allocation parameters. They are not designed to take big bets between asset classes – if they did, their risk profiles could well become incompatible with the profiles of the funds’ investors at any given time. Comparing the performance of risk-profiled funds to funds which take much bigger asset allocation bets is therefore inappropriate – it’s like comparing apples to pears. The performance of a risk-profiled fund should be compared to its strategic asset allocation benchmark. This is because the strategic benchmark is a proxy for the client’s risk profile and this should be taken into account when analysing performance of any risk based solution. It may sound obvious, but if a fund is performing in line with or ahead of its benchmark, then it is meeting the needs and expectations of the underlying investors. It is for this reason that many providers of risk-profiled funds, including Fidelity, have removed their funds from the IMA peer groups.

Consequently, we recognise that it’s not easy to compare risk-profiled solutions to each other but believe that there is no substitute for an in depth review of each solution under consideration as this is what allows the adviser to gain a solid understanding of the approach taken – and the investor outcomes expected. By investing time at this early stage, the adviser can demonstrate they have met suitability requirements in selecting the most appropriate long-term solution for their client, which in turn should lead to a long-term happy client base.

For more information please contact your local Fidelity representative, visit our website at fidelity.co.uk/multiasset or call FidelityLine 0800 368 1732.

About James Bateman

James Bateman is Head of Portfolio Management for Fidelity’s Investment Solutions Group. The Investment Solutions Group is a 23-strong team* of specialists

in solutions design, tactical asset allocation, manager selection and risk management. The group has a 20-year history of developing solutions tailored to match specific client objectives and risk profiles. Based in London, Paris, Tokyo, Singapore and Hong Kong, the team manage more than £28 billion* for investors around the world.


* Source: Assets and resources are those of FIL Limited as at 31 December 2013.

This article is for investment professionals only and should not be relied upon by private investors.

This article is for Investment Professionals only, and should not be relied upon by private investors. The value of investments can go down as well as up and clients may get back less than they invest. Investments should be made on the basis of the current prospectus, which is available along with the Key Investor Information Document, current and semi-annual reports, free of charge on request by calling 0800 368 1732. Issued by FIL Investments International, authorised and regulated by the Financial Conduct Authority. Fidelity, Fidelity Worldwide Investment, the Fidelity Worldwide Investment logo and F symbol are trademarks of FIL Limited. RM0514/3379/SSO/1114