Portfolio risk descriptions – fact or fiction?

By Dave Chessell

Go to the profile of PortfolioMetrix
Jan 29, 2020
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What’s in a name? Quite a lot if it’s a risk descriptor for a portfolio of funds. Most come with names that are designed to give an indication of their risk rating: Cautious, Balanced, Growth, Adventurous etc.

However, a quick look under the bonnet of some of the most popular model portfolios reveals a sizable disparity between the risk level you would expect from the name and the actual level of risk that these portfolios are taking.

It’s a topic we’ve covered before– we even produced a white paper that went into detail on the issue back in 2018, yet it seems little has changed.

A recent article by Holly Mackay from Boring Money is a good case in point.  When looking at the ‘Balanced’ portfolios, she sums it up perfectly in just one sentence: “[There is a] Huge difference in ‘medium risk’ solutions – you might get a Korma or a Vindaloo.”

The PortfolioMetrix investment team are very focused on risk. This chart showing five-year performance* of our portfolios compared to some of the popular ‘Balanced’ competitors is a good illustration of this

And this chart highlights how we compare* to ‘Growth’ portfolios:

Actually, the fact that the names of many of the portfolios don’t align to their risk rating is just the first piece of fiction. Other issues include:

Fiction: the scale labels given to risk-rated portfolios align with the scale labels used in off-the-peg risk mapping tools.

Fact: they don’t.

Fiction: the volatility target of the risk profiling scale always matches the volatility target of the portfolios.

Fact: the same risk model needs to be used in both cases for this to work.

Fiction: even if the risk profiler firm has done the mapping to the portfolios, that mapping will not degrade over time.

Fact: it will degrade unless the investment management methodology matches the risk profiler’s methodology.

As Holly Mackay says in her article, “Certain providers might have got you from A to B faster over the last few years, but if they’ve driven at 120 mph on the way, are you comfortable with that?”

With the UK regulator holding advisers responsible for ensuring their clients’ appetite to risk aligns with the risks taken in the investment portfolio, it is essential that advisers are confident they are choosing investment portfolios that are correctly risk aligned and using tools that ensure there’s a perfect marriage between client appetite and the actual risk. Fact.

* Past performance is no guarantee of future results.



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PortfolioMetrix

PortfolioMetrix are a multi-award winning, innovative investment manager that provides independent financial advisers with an alternative way to access discretionary investment management for their clients. Our proposition comes at a competitive price and doesn’t compromise the adviser/client relationship. The London winner of the Citywire Wealth Manager Regional Stars award for two consecutive years, voted the WM Small Business of the year, in association with ARC 2018 and, in 2019, have received the accolade of PA Discretionary Manager of the Year. Our proposition offers the convenience of online model portfolios yet delivers customised portfolios, tailored to individual client requirements. Investment performance has demonstrated consistent and reliable risk and return separation of portfolios that doesn’t undermine the financial planning process. This is achieved through our academically-robust, risk-based investment approach. WealthExplorer™ is integral to the PortfolioMetrix customised service. A proprietary owned and designed software system, WealthExplorer™, is purpose built to equip advisers with a broad range of tools designed to deliver unique client insights that add value to the adviser/client relationship and ultimately delivers better client outcomes, when utilised by financial advisers.

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