Regulators often take time to respond to high profile investment problems - a considered response is needed. But already there are things to be learned. In particular, risk measures based on volatility can give very misleading signals. Summary Risk Indicators (SRIs) shown in fund Key Information Documents have two main failings. In emphasising the past, SRIs may encourage investors to think of risk as something stable and predictable, that they can extrapolate into the future. And worse, the key problem shown by recent events is that the methodology actually favours funds with less liquidity and poorer price discovery.
Viewed as the risk that investors may not be able to readily redeem at the prices shown – rather than thinking of daily volatility – funds with illiquid investments are, of course, actually riskier. The lack of price movement means less certainty over value. Investors and advisers need to look beyond these summary statistics to gain a better understanding of how risk is managed within funds.
Certainly, the revision of the Indicator in 2018 did bring in an element of credit risk, but the calculation still emphasises market risk in an unusual way. The scores that emerge - ranging from 1 to 7 - may at the extremes point to fund characteristics. But there is little real world experience of any real world differences between ratings of 3, 4, and 5. The danger is not just giving false comfort to some investors. It might divert attention from some sound investment strategies that usefully correlate less with others, and accordingly can help to manage portfolio risk.