3 Questions Advisers Should Ask About Risk-Rated Portfolios

Advisers should think carefully about how and why they are using risk-rated model portfolios, according to Twenty20 Investments’ managing partner Allan Lane, as these products become increasingly popular.

Lane pointed out in his blog, published today, that the way we measures risk within these products is self-regulated and can vary from provider to provider.

“With the financial advisory market employing a framework of self-regulated risk rating methodologies it is perhaps worth spending a moment reviewing the key aspects of the proposition to better understand which factors one needs to look at to calculate – and forecast – risk,” he wrote.

Many of the portfolios on the market were launched since the global crash of 2008 and therefore have relatively short track records and may not have been through a complete market cycle, he warned.

Three questions advisers should ask about these funds are:

1) How well has your risk framework performed during the recent market volatility?

Lane said advisers should ask their investment managers for information regarding drawdowns and standard deviation of returns during spikes of market volatility, so they can see whether the information matches the risk rating.

2) How does one rate the risk of a tactically allocated model portfolio?

If advisers invest in a tactical portfolio, they should look at the full history of that portfolio and how it is constructed, and what it has invested in over time, said Lane.

3) How does the Synthetic Risk & Reward Indicator (SRRI) risk band framework differ from other risk rating models?

The SRRI system calculates five years’ worth of weekly return data to calculate the level of risk, but Lane encouraged advisers to do their own empirical estimates of the model portfolios’ maximum drawdown.

“For a strategic portfolio this can be estimated by calculating the weighted average from the full list of asset class exposures in the solution,” he wrote. “For a tactical portfolio one can only reasonably do this by assessing the risk over the simulated path which includes all rebalancing processes, thus testing the investment process’ ability to control the risk of the portfolio across all economic regimes.”

Lane has previously called the plethora of risk-rated model portfolios "cookie cutter" solutions which are too "hands off" for today's environment.