Underneath the bonnet: Four key mechanics of Fund Risk Profiling

Speculate to accumulate – very nearly all of us must do it with our pensions and investments as we prepare for retirement.

Very few of us can afford to meet our goals without taking at least some level of risk with the money we have worked so hard to accumulate. As end clients and investors, we must, of course, understand the natural trade-off between risk and reward to reasonably reach the right decision for us.

Projected risks and returns of different investment scenarios, when considering decisions, must be credible, accurate and consistent.

With such a rich and varied market of investment solutions available to suit different client preferences, characteristics and objectives, there needs to be a clear and robust method to compare and categorise the risks of those solutions fairly, accurately and consistently, so that they can be suitably matched to clients. Makes sense.

But how do you do that? What, in short, is the answer here?

Key 1: Categorise clients into distinct groups

Dynamic Planner approaches this problem by dividing the retail investment market into 10 segments – a simple and intuitive 1-10 risk scale, where one represents the lowest level of risk and 10 the highest.

Each market segment is based on the expected volatility (standard deviation of returns) and 95% Value at Risk – the potential fall over any one year with a 95% level of certainty. Dynamic Planner provides an example or benchmark asset allocation for each market segment on which the illustrated risks and return profiles are based.

Key #2: Understand long-term risk and return of different investments

Working closely with leading academic and global risk consultancies – and using proven, empirical economic and actuarial practices – Dynamic Planner determines the long-term real returns and volatility of 49 asset classes, defined by indices, as well as how they behave in relation to each other.

It further maintains a database of more than 20,000 instruments presently held within the 1,400-plus funds currently risk profiled each quarter.

Key #3: Understand precisely where the client is invested – and why

Each fund is separately assessed for equity risk, interest rate risk, currency risk, basis risk, holding period risk, credit risk, liquidity risk, concentration risk and finally counterparty risk. Based on that, one or a combination of the 49 asset classes that best represents it is applied to each holding’s individual risk characteristics.

Key #4: Determine and monitor the risk of investments

At Dynamic Planner, we receive detail of the holdings, trading and tactics within each risk profiled fund to provide the most accurate assessment of the risk and reward an investor could expect. As a result, we can accurately risk profile any combination of assets.

In that light, advisers and indeed asset managers building investment portfolios are not restricted to prescriptively following the Dynamic Planner benchmark asset allocation for the respective level of risk. How then does Dynamic Planner benefit you and your firm?

By accurately managing a client’s risk and reward expectations, you effectively dilute any potential dissatisfaction and the need to perhaps placate and reassure clients, whose portfolios have performed disappointingly over the previous 12 months. Keeping your clients happy, of course, minimises the danger of losing them in future.

Being able to assess the client’s and a solution’s risk and reward quickly and consistently reduces workloads and worry for your firm.

You can be safe in the knowledge that Dynamic Planner can very accurately assess any combination of assets within an investment, which, in turn, accurately reflects a client’s preferences, objectives and characteristics and ultimately their risk profile.

What do advice firms say?

“Dynamic Planner makes life more simple, in short,” says Louise Jones, an adviser in Devon and the South West. “It means we don’t have to complete lots and lots of fund research – because Dynamic Planner has already done it for us.”

Tom Orchard, an adviser with Wiltshire firm Annetts & Orchard: “Dynamic Planner does lots of great and different things, but the bottom line for us is that when we, as a firm, risk profile new clients – and regardless of where they sit on the scale – we know that the investment we are recommending has been carefully mapped.”

Tom added: “Dynamic Planner allows us to match an agreed risk profile with a suitable investment. That, in a nutshell, is what it does and is where the value it has added to our business lies.”

Of course, in a market downturn, clients should not be shocked by falls in value of their investments, which should also help prevent them making any knee-jerk decisions to their potential long-term financial detriment. Knowledge prior of risk within a portfolio is power, in that sense – the power not to panic.

We could all, surely, use some of that.

Read more about asset allocation within Dynamic Planner.