The growing interest in these solutions has helped fuel market growth in risk-targeted funds offered by a variety of fund management groups.
What makes a solution risk-targeted?
Risk-targeted solutions are designed to provide and maintain a suitable combination of asset classes and they should rarely deviate from the risk parameters stated with the client. The fund manager aim is to ensure the asset mix within the fund continues to meet the client’s profile and does not simply try to beat a sector average performance.
Although, as previously mentioned, the most common measure of risk used is volatility (standard deviation), some investment managers will sometimes use other measures such as maximum drawdown, value at risk and liquidity.
The multi-manager market in the UK has evolved in recent years to the extent that there are two distinct sub-universes that would be assessed separately. In the past, multi-manager funds have focused on returns; either absolute or relative to a peer group or benchmark.
More recently, however, fund ‘families’ that focus on or target risk have been developed and launched.
This chart shows the growth in the risk targeted universe in the 10-year period from 2003 to 2013, for both the number of fund families and the total number of funds within the families.
The aim of these families is to offer investors a range of funds, each one providing a stated level of risk or band of risk. Each member of the range should steadily increase risk and therefore provide a greater potential return.
Step by step through the process
The investment process is usually consistent across all the funds in the family, but the asset allocation – both strategic and tactical – for each fund will vary in order to meet and adhere to the stated risk parameters.
Periodic rebalancing to ensure each fund remains within these risk parametersis of course also a common feature within these fund families.
So how do you choose the appropriate solution? In the case of risk-targeted funds, all the funds in the family are taken together when assessing performance and judging appropriateness.
An approach is to look at four measures, which specifically apply to these funds:
• Shape measures the conformity of the family of funds to the expected risk versus return correlation, where an increase in risk is associated with an increase in return, with a closer fit to this pattern better rather than having a haphazard pattern
• Spread is the measure of the breadth of risks available in the family of funds and is calculated as the difference between the maximum and minimum standard deviation, with a wider spread being better
• Consistency is a measure of how evenly spread the risks are in the family of funds and is calculated as the variance of the changes in risk when moving from each fund within the family to the next most risky one, with a lower variance getting a higher score
