23rd September 2014

Scottish Life: Risk targeted vs risk rated

The popularity of centralised investment propositions (CIPs) amongst the adviser community has gone through the roof in recent years. Why has this happened and do you know the differences between a CIP that is risk-rated and one that's risk-targeted?

Why the popularity in CIPs?

A CIP is a blanket term given to any form of investment solution that can be used to outsource an adviser's investment process. These solutions can provide a consistent, repeatable process which is affordable for your clients and profitable for you to deliver.

You can use CIPs to delegate responsibility for investment decisions and help de-risk that part of your business and can be a lower cost than providing a bespoke solution for your client. In this context, there's little wonder why they've become so popular.

However, there are different types of CIPs and different ways of labelling them. Here, we look at the differences between risk-targeted CIP and a risk-rated CIP.

Risk-targeted = forward looking

Risk-targeted CIPs have a specific objective to maximise returns to investors within a defined risk profile. There are many ways to measure risk but typically, this is measured in terms of volatility bands and provides an indication of how the solution will be managed in the future. If a risk-targeted, CIP is labelled as 'balanced', it will be managed on an ongoing basis to a level of risk deemed appropriate for 'balanced' investors.

Risk-rated = backward looking

A risk rated CIP means that the fund has been given a risk profile at a point in time, usually by a third party, based on how the fund has performed historically. This approach provides no indication of the fund's future expected performance. Risk ratings are usually reviewed on a regular basis and it is possible for the fund's risk rating to be changed as a result of a review.

If a risk-rated CIP has a risk rating of '5', for example, there is no guarantee that it will remain at a '5'. It is not being managed to a defined level of risk associated with a rating of '5'.

What's the Regulator had to say about these types of investments?

As the popularity of CIPs has increased, so has the regulatory scrutiny. The Financial Conduct Authority (FCA) has concerns that CIPs are used as a shortcut to suitability and that some clients are shoehorned into solutions which are inconsistent with their attitude to risk, investment objective and time horizon.

The FCA also has concerns that risk-rated CIPs are being recommended on the basis that they will be managed to a level of risk associated with its rating.

It's all about conducting due diligence on any CIP you recommend, having a clear understanding of target market, objectives and amount of flexibility to meet your individual client's needs and objectives.

How do we target risk?

Our Governed Portfolios target specific levels of volatility. Find out how we do this in our sales aid Managing risk in the Governed Portfolios.

Our Governed Retirement Income Portfolios (GRIPs) are our CIP for drawdown. Like the Governed Portfolios they are risk-targeted but use a different measure of risk called downside risk. Find out how and why in our sales aid Managing risk in the GRIPs.

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