Are your investments putting your money at more risk than you thought?

Financial advisers accused of sliding towards more exposed portfolios

Kate Hughes
Money Editor
Wednesday 22 November 2017 20:21
Risk and reward: do you know how exposed you are to a ‘significant event’?
Risk and reward: do you know how exposed you are to a ‘significant event’?

Investors around the country and beyond are unwittingly exposing their hard-earned income to greater risks than they realise as financial advisers drift away from traditionally cautious assets and into risker options.

That’s the conclusion of the latest barometer that examines how a range of standard investment portfolios are put together.

The Natixis Investment Managers Portfolio Barometer, which tracks the activity of 70 UK risk-rated model portfolios in “conservative”, “moderate” and “aggressive” categories, has revealed what it describes as “disproportionate risk profiles”.

Based on their equities or stocks allocation, and because of a lack of diversification across other asset classes and strategies, such as bonds or cash, Natixis has warned that the risks are being understated to investors.

Demand for returns

Its findings suggest that in numerous investment portfolios labelled as “conservative”, a “significant risk event”, such as the 2008 global financial crisis, could result in average losses of more than 10 per cent of an investor’s money.

Portfolios identified as “moderate” could expose investors to losses of around 20 per cent due to a market correction – a sudden drop in an index, stock, bond, or commodity as an adjustment for overvaluation, for example.

Meanwhile, “aggressive” portfolios with equities typically accounting for 92 per cent of the investments carry with them the risk of losses of around 94 per cent. That, the manager says, implies there are minimal benefits from diversification outside of equity risk.

“Clients [of financial advisers] may not expect a portfolio from the middle of a risk range and marketed as ‘balanced’ to have a possibility of losing around 20 per cent in a significant market correction,” says Andrew Kinsey-Quick, senior consultant at PRCG, for Natixis Investment Managers.

“In reality, ‘conservative’ portfolios are probably the most balanced in their approach to allocations and risk – to the degree that one could consider them as ‘moderate’ portfolios in their construction and approach.

“In ‘conservative’ portfolios we are seeing a demand for returns pushing investors towards higher risk assets and strategies, with current exposures leaving them open to levels of losses that they may not be prepared for, or fully comprehend.

A ‘durable’ appetite for risk

“Balancing return expectation with a durable risk profile may be becoming more difficult for advisers. Yet in spite of these challenges, our view is that there are strategies that can improve diversification with only partial impact to performance, and it is worth advisers searching their investment universe more thoroughly to source such opportunities.”

But many dispute the findings, including wealth manager Philippa Gee, because of close, ongoing, observation and updating.

“A good portfolio would be regularly reviewed and monitored to reflect the ever-changing risks and dynamics of markets,” she says. Also, looking at recent years, the allocation to bond holdings could have reduced to reflect the particular risks of that market at that time. A portfolio should be an ever-evolving construction, rather than something permanently fixed.

The critical point is that, even with a more cautious portfolio, if the holdings are not 100 per cent cash, then there is a risk.

“If stock markets fall significantly, that will impact upon even the most cautious portfolio. Say the FTSE falls by 20 per cent, an invested cautious portfolio could still fall by 5-10 per cent depending on the underlying assets and the type of market fall, although it is likely to be nearer 5 per cent.

“Having agreed a risk, then it is crucial to know exactly what that risk involves and the implications. If no risk can be tolerated, then the pursuit of higher returns is wrong.”

Anatomy of an investment portfolio

There are three broad types of risk, notes Danny Cox, a chartered financial planner and head of communications at Hargreaves Lansdown.

“Risk required is the risk you need to take in order to meet your objectives. For example if you need a 6 per cent return over 10 years, at the extremes a cash and investment grade portfolio won’t get you there, but an equity income portfolio might.

“Risk tolerance is the sleep-at-night risk – the amount of risk you can withstand,” he says.

Finally, risk capacity is the amount of risk you can afford to take. In other words could you afford to lose 5, 10 or 20 per cent of your money at any one time and still get by.

He believes the shift up the risk scale towards equities reflects the current interest rate climate, particularly for investors looking from an income from their investors.

“Low interest rates make cash a non-starter for income, forcing investors to commit more of their capital to shares. Low bond yields are doing the same and this is combined with the greater risk to capital which bonds bear when interest rates rise, making fixed income less attractive.

“It is the financial adviser or wealth manager’s responsibility to ensure the funds and portfolio are appropriate for the level of risk the client needs to take. If the level of risk changes within a portfolio this should be addressed at review to ensure suitability,” he adds.

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