EU Urged To Fine Tune Fund Risk Ratings
Thursday, March 18, 2010

Moves by European regulators to provide a standard risk rating for investment funds needs further refining to make them truly effective for consumers, according to representatives of the UK insurance and investment fund industry.

The Committee of European Securities Regulators (CESR), put forward its proposals for a standardized 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 for UCITS funds, starting from the second half of 2011.

However, joint research released on March 15 by the Association of British Insurers (ABI) and the Investment Management Association (IMA) shows that 70% of asset classes rated using the proposed method in 2006 would have had their risk categories changed only three years later.  The research found that doubling the period of data used when assessing the relative risk of a fund leads to a significantly more reliable risk indicator.  Changing from five to ten years reduces the proportion of asset classes that would have had their risk indicator changed between 2006 and 2009 from 70% to 30%.

The research also found that under the CESR's proposed scale of seven risk categories, a third of asset classes and half of all funds would fall into one category alone. The ABI and IMA therefore recommend adjusting the boundaries to give a better spread across the categories and so help consumers to choose between different funds.

"CESR's recommendations to the European Commission on the methodology to create a synthetic risk reward indicator do not meet its own criteria, namely that the results should avoid excessive bunching and that the rankings should be relatively stable over time," concludes the joint research brief by Rebecca Driver, Director of Research at the ABI and Julie Patterson, Director of Authorized Funds & Tax at the IMA.

"Using a longer span of data to calculate the synthetic risk reward indicator significantly helps to increase stability because it captures a wider range of market conditions. Using 10 years (rather than five years) of data to calculate the risk reward indicator would have significantly improved the usefulness of the risk indicator during the current crisis," the research note adds.

Driver commented: "Improving the way in which investment risk is explained to consumers has the potential to deliver significant benefits.  The rules as proposed do not yet fully deliver that benefit.  We hope the research work released today will help the Commission as it looks for the best solution."

Patterson added: "Reducing investment risk to a single indicator for an individual fund is neither easy or a solution in itself to the complex investment decisions that consumers face. Our joint research shows how the workings of the proposed indicator could be improved to enhance significantly its usefulness to consumers."