News from Cass Business School

New risk rating for investment funds allows investors to choose appropriate fund

Research from Professor Clare aims to help people to compare funds

Tuesday, 30 March, 2010

New research from Cass Professor Andrew Clare assesses how to calculate a standardised risk disclosure metric for investment funds, allowing investors to make meaningful comparisons between funds.
This standardised approach to calculating risk disclosure is important because if rankings applied to individual funds shift frequently and by large amounts this is likely to confuse investors and undermine the value of the risk indicator as a decision tool.
The research, titled Developing a risk rating methodology, and commissioned by the Investment Management Association (IMA), comes after the Committee of European Securities Regulators (CESR), put forward its proposals for a standardised risk and reward rating methodology in December 2009.  It is now being considered by the European Commission for use when firms produce Key Information Documents (KIDs) for UCITS funds, starting from the second half of 2011.
Of the range of risk metrics investigated in this research surprisingly standard deviation provides the most reliable forecast of future risk rankings.  It was also found that in general, the longer the period used to calculate the risk measure the more reliable the subsequent results.
The research also argues that an asset class based risk rating process that makes use of standard deviation as the underlying risk metric could also be extended to incorporate multi-asset class funds, absolute return funds and possibly to structured products of the capital guarantee kind too.
Professor Clare also argues that fund-specific details relating to each fund’s appropriate investment horizon, tax implications, guarantees and to fund manager-specific risk are best dealt with in the disclosure document and by financial intermediaries.
A standardised risk ranking methodology for mutual funds and for structured products has the potential to have a significant impact on retail investing, says Professor Clare.  If the EC get the framework wrong the consequences could be very damaging for the industry.  The proposal in my paper, is effectively to keep it very simple and transparent.

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Professor Andrew Clare

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