FE portfolio risk tool will give ‘opaque results’

risk graph blackboardA new tool portfolio risk score tool launched by FE Analytics will not show a clear picture of risk, say experts.

The FE Portfolio Risk Score, launched today, defines risk as a measure of volatility relative to the FTSE 100 and is recalculated weekly for funds with a minimum 18-month track record.

But experts say the criteria behind the tool and the way it is built offer challenges.

Axa Wealth head of investing Adrian Lowcock says that limiting the benchmark to the FTSE 100 will not give a clear risk assessment of funds.

He says: “The FTSE 100 is a well-known and common index for UK investors and while it does reflect the bulk of the UK market by market capitalisation I would have preferred the FTSE All Share as a more diversified benchmark.”

Tilney Bestinvest managing director Jason Hollands agrees that this is a “seriously limiting factor” and instead thinks that absolute volatility should be used as the measure.

However, FE director Mika-John Southworth says the FTSE 100 was selected because it is a benchmark that most people in the UK “can get their head around”.

The FE tool will award portfolios a score of between one and 150, says FE, with direct equities falling above 100 and pure cash at zero.

Lowcock says that defining cash as risk free and so giving it a zero rating is problematic.

He says: “I feel we all too often refer to cash as risk free. Whilst it is unlikely that any investor will lose money in cash, it is possible. More so, cash does have its risks such as inflation or opportunity cost. I think it is important to clearly represent cash’s risk in portfolios.”

While Lowcock welcomes the fact that funds are risk scored from as early as 18 months after launch, given that the risk score is based on a rolling three-year performance, he says some clarification of how this is achieved is needed, possibly with an appropriate risk warning.

He says: “Funds with short-term track records are more susceptible to their sector’s performance relative to the FTSE 100, which in the short term could be anywhere.”

Hargreaves Lansdown senior analyst Laith Khalaf says the use of mechanistic scores, which condense the analysis of funds into a single number, oversimplifies the nature of risk.

It also only gives advisors a snapshot in time as the level of volatility in markets is constantly changing. “If you’re relying on these scores too heavily you’re driving along using the rear-view mirror,” he adds.

“It is simply impossible to eliminate the qualitative research aspect of portfolio construction; scores like this can inform that process, but they can’t replace it.”

Southworth says: “Risk is a very complex subject for non-financial experts to understand. Our risk scores were designed to address this challenge and make investing more accessible and transparent.

“The risk scores should never be used as the only way of selecting a fund or building a portfolio. They are available on FE Analytics and Trustnet along with many out more detailed and complex tools for measuring risk and volatility.

“Put simply, the aim of the FE risk scores is to provide a clear, easy to understand, comparable framework for advisers who are trying to communicate with their clients.”