We have a rigorous and scientific methodology for mapping investors to investments.
Establishing an investor's Suitable Risk Level
The starting point is an investor’s Risk Tolerance. It’s crucial to measure this accurately, grounded in the science of what’s reliable[1].
Investors should then consider their Risk Capacity. In other words, how does their portfolio work for them in the big picture, balancing their wider financial situation?
Finally, take investing experience and composure into account. Suitability is as much about what people expect – and can stomach – as much as tolerance of uncertainty.
Quantifying investment risk
Focus on what matters to investors: their long-term future, not recent volatility.
We define investment risk as the standard deviation of prospective 10-year returns.
To do this, we simulate many thousands of possible return paths, based on an investment’s asset allocation. Our risk engine generates scenarios which include effects like momentum, mean-reversion, and dynamic correlations.
Defining risk bands
In short, we assume that investors in each risk band pick optimal portfolios. We solve for the theoretical risk they each take.
If you would like more detail about the method, please do get in touch – we believe our approach is unrivalled in its robustness.
Mapping to funds and portfolios
Once you have identified the suitable risk level for the client, you can recommend a fund or portfolio that maps to that level. We have a large – and ever growing! – set of publicly available mapped funds, and we can also map bespoke portfolios.
Example asset allocations
We have sets of example asset allocations to help provide a sense of what a suitable portfolio might look like for each risk level.
For 5 risk levels
Cash | Government Bonds | Corporate Bonds | Developed market equities | Emerging market equities | |
Low | 30% | 40% | 10% | 20% | 0% |
Medium Low | 15% | 30% | 15% | 35% | 5% |
Medium | 5% | 20% | 15% | 50% | 10% |
Medium High | 5% | 5% | 10% | 65% | 15% |
High | 0% | 0% | 0% | 75% | 25% |
For 7 risk levels
Cash | Government Bonds | Corporate Bonds | Developed market equities | Emerging market equities | |
Very Low | 35% | 40% | 10% | 15% | 0% |
Low | 15% | 45% | 15% | 25% | 0% |
Medium Low | 5% | 30% | 20% | 40% | 5% |
Medium | 5% | 20% | 15% | 50% | 10% |
Medium High | 5% | 10% | 10% | 60% | 15% |
High | 0% | 5% | 5% | 70% | 20% |
Very High | 0% | 0% | 0% | 75% | 25% |
[1] See https://www.cfainstitute.org/research/foundation/2017/new-vistas-in-risk-profiling and https://www.cfainstitute.org/en/research/foundation/2018/risk-tolerance-and-circumstances
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