Risk: We Need Standards

by | Oct 13, 2014

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Gill Cardy wants a more universal understanding of risk


 

May the heavens bless the FCA for continuing to focus attention on risk profiling – even if the regulator is being oblique about its expectations, and annoyingly opaque about which tools are acceptable, appropriate, suitable, accurate, valid, or any of these.

But even if we did know what the FCA finds agreeable in the world of risk-profiling, I humbly suggest that we first need a clear understanding of what we mean by risk.

While I’m doing clarifications, by ‘we’ I mean not only advisers and investment managers, but also other key stakeholders in this discussion: clients, the FCA, and those other judges and juries of our advice, the Financial Ombudsman Service.

So What is Risk?

Now, I know there are concerns about the general levels of understanding of investment risk in the adviser community, and this is one good reason why we should agree an intelligent approach which can work for all of us.

None of you need a lesson from me on risk.  There is a ‘risk’ attached to just everything, and the important thing, therefore, is to understand it and then quantify & control it.

When considering attitude towards investment risk, investment advisers and clients often have different definitions of risk, let alone approaches to risk, which can cause confusion and investment in inappropriate portfolios.

Types of Risk:

  • Systemic risk (war, taxation, natural disaster)
  • Capital risk
  • Non-systemic risk (incompetent fund management)
  • Income risk
  • Risk of loss
  • Time risk
  • Underperformance
  • Failure to achieve objectives
  • Likelihood of an event
  • Impact of that event
  • Volatility
  • Inflation

Of course, it’s any or all of the above, and some of them are the same thing expressed differently depending on whether you are an investment manager or a client.

It’s In the Charts

There’s one chart in our core study text that’s been around for years.  It’s the one where risk is mapped across the bottom and return is mapped up the side of the chart.

You draw a line from bottom left to top right and write along that line all the main investment categories in order of risk.  You start with cash in that bottom left hand corner.  In the study text venture capital is at the top right, curiously above Enterprise Investment Schemes which I would personally assess as higher risk than VCTs.

Below these (curiously) is ‘property’ without any further distinction between residential or commercial.  Then we find ‘unlisted shares’ followed by ‘listed equities’.

This type of chart usually refers to other countries, distinguishing between the differing risks of UK, developed or emerging market investments.   In addition, individual shares are described as higher risk than collective investment funds.  They have no investor protection.  They lack diversification by most measures (number, sector, market, economy) and have little or no asset class diversification.

But when FOS asserts in an adjudication that FTSE-100 shares are low risk investments we must all agree that there is an urgent need for ‘clarification’: a common understanding, one to which all stakeholders in the financial services community could subscribe, and one with which they (we) could all abide, in the short, medium and long term.

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