We are now one year away from the spring 2020 crash and volatility, and as the country takes interim measures to emerge from the lockdown, risk remains a priority for many investors and their advisers.

I am convinced that the fluctuations of the last 15 months are also on the mind of the Financial Conduct Authority, as they are working on the postponement of the adequacy assessment 2, which has the published goal of focusing on the advice that consumers receive regarding retirement income. The pandemic will have provided even more time for reflection. As in any stock market crisis, older retail investors with less time to recoup losses potentially have the most to lose.

It is also the older generations who have the most to invest and any crisis of confidence within this group could have significant consequences. Across the UK and Europe, governments and asset managers need functioning investment markets and committed retail investors to support their post-pandemic reconstruction programs.

Risk / reward indicators

Risk is also on the minds of EU regulators, with a recent decision to try to end the UCITS exemption and potentially apply the PRIIPs DIC and Summary Risk Indicator (SRI) to from January 1, 2022, subject to the approval of the European Parliament and the Council – although this is still under debate.

This is neither the time nor the place to discuss the differences between the Synthetic Risk Reward Indicator (SRRI) of UCITS and the SRI of PRIIPs. What is the case, however, is that many funds over the past year – at one point over 40% of UK UCITS according to FE FundInfo – have had to change their risk indicator over the past year. because their risk levels have changed. The investor was tricked into believing that he was investing in a fund with a risk / reward characteristic, but in fact, when the risk did manifest itself, it turned out that he was sometimes investing in something else.

It actually takes time when you consider that for either diet the risk expectations are so wide it’s like trying to style your hair with a garden rake. For comparison, the potential results for risk levels 3 or 4, the two most commonly used categories, cover Seven different risk profiles in Dynamic Planner.

Historical performance

The situation of the advisor and the investor – and ultimately the manager – if complaints ensue is significantly worsened by the fact that risk indicators project on the basis of historical performance, which means that the period of relatively low volatility market up to early 2020 was reflected in lower risk indicator scores at the very top of the market.

It is only when the volatility of a fund has crossed its category limits for 16 consecutive weeks that the manager must change the wording of an SRRI. So when you look at the actual performance of funds in SRRI 3, for example, the investor might have experienced annualized volatility ranging from 1.5% to 17.5% in the past 12 months. Obviously, it’s very difficult to manage expectations, let alone build a precise financial plan, around such broad ranges.

While these high-level regulatory risk labels are useful in that they classify widely different categories of investment products – for example, leveraged versus non-leveraged products – labels based on past performance cannot be any indicator at all.

As investors and their advisers increasingly rely on risk-based retirement plans, the need for increasingly precise planning and a closer relationship between manager, advisor and manager. customer increases. Consider a client with a pot of £ 250,000 at retirement. They would consider accepting a value at risk of £ 22,000 or £ 46,000 if they chose between risk profiles 3 and 7 at 95% in Dynamic Planner. This is obviously an important difference and yet these profiles belong to a single SRI category.

A constantly evolving vision

To assess risk successfully, you need to look ahead and maintain an ever-changing view of asset class risk – the primary determinant of variation in returns – using a covariance matrix that takes correlations into account. asset classes.

To manage the risk of decumulation, it is essential not only that the investor is informed precisely about his needs and his ability to take the risk, but that the investments are in fact managed against this risk each month – not on the basis of this risk. a quarterly basis, let alone annual. When an investment manager only reports that he has exceeded volatility limits 16 weeks after the fact, then if the client is continually withdrawing income in a declining market, the damage is already done.

Risk-managed decumulation requires even tighter targeting of forward-looking expectations. Looking at the universe of targeted risk-managed capitalization funds against the risk profile of Dynamic Planner 4, for example, in 2020 a single fund deviated from its monthly value in anticipation of risk, then for a period of time. months only.

Fortunately, risk targeting in both accumulation and decumulation is becoming more prevalent, with managers supporting consulting firms that frame their proposals on a series of tightly managed, forward-looking risk profiles. . The result is that investors and advisers have much clearer expectations and can plan accordingly.

Ben Goss is CEO of Dynamic Planner

By Portfolio Advisor, May 19, 21