This also means clients need to be very careful when selecting a smart beta fund that they are choosing a factor that has return potential.

Impact on clients?

Those are a couple of the most widely used risk models in fund management and client advisory.

Volatility and the asset class model is currently very widespread, while the factor-based approach is still largely in the domain of more sophisticated fund management houses.

While factor-based smart beta funds have been around for a few years now, it remains unclear if these will become attractive to investors and clients in the future.

The main stumbling block hindering their uptake by advisers is assessing smart beta funds for their suitability.

At the moment there are no adviser tools that use a factor-based approach to assess fund risk.

Can advisers independently assess absolute return fund risk?

Similarly, how to assess fund suitability also applies to absolute return funds which use a large amount of derivatives or aren’t traditional long-only funds.

This is a larger problem as many post-retirement clients are now investing into drawdown portfolios and, consequently, absolute return funds have become very popular.

Currently, most absolute funds are recommended based on their historic performance, targeted return and volatility, the latter of which is provided by the fund manager. Independent assessment of their holdings and strategies won’t be possible until advisers are able to use a factor-based approach.

Given the uptake of risk assessment tools was mainly driven by RDR, it is hard to see what could drive advisers to use these newer factor models now without another update in regulations.

Therefore, it appears that the asset allocation and forecast volatility fund risk assessment method will be the most common model in use for some time yet.

Despite its drawbacks, it’s still a relevant tool for advisers helping clients plan for the long-term. 

Jason Baran is insight analyst at Defaqto