A surprise about regional balance in "high" and "low" risk funds

redonion

My Standard Life work pension scheme divides up its "Low Involvement" choices into "Opportunity" and "Balanced" funds. Standard Life Managed Pension Fund is in the latter ("Balanced" -- low risk) category. Trustnet categorises the asset allocation for that fund as follows:

International Equities 41.60
UK Equities 36.70
Money Market 6.30
UK Gilts 4.70
Global Fixed Interest 4.20
Asia Pacific Fixed Interest 2.90
UK Fixed Interest 2.80
UK Index-Linked 0.80

So, only 14.6% outside of equities and money markets in this allegedly lower-risk investment -- very small compared to the 40% recommended by "Ultimate Buy and Hold". Why so low?


A fund they put in the [STRIKE]"Balanced"[/STRIKE] argh, I mean "Opportunity" category -- allegedly higher risk is SL Baillie Gifford Managed Pension Fund. Again, here's Trustnet's asset allocation:

UK Equities 34.50
North American Equities 14.50
Europe ex UK Equities 13.80
Global Emerging Market Equities 12.60
Fixed Income 9.10
Asia Pacific Equities 7.90
Money Market 7.60

So: only 9% fixed income -- lower than the allegedly lower risk fund above, but not dramatically so. More puzzlingly, 62.8% in Europe / USA equities in this allegedly higher-risk fund -- i.e. apparently a far lower proportion of the investment in high-growth areas of the world than the "Balanced" fund above (20.5% vs. 41.6%). I find that surprising. I imagine the low-risk fund's "International Equities" is spread around a lot more than the higher-risk fund's "Asia Pacific" and "Emerging Markets". But why is the non-European/US component in the high-risk fund so low?

I understand that these categorisations only tell part of the story. But can anybody suggest what's behind these figures? And why the bonds component in both funds is so low compared the "Ultimate Buy and Hold" recommendation?

Linton

"Low involvement" doesnt mean low risk. It means that you as an investor neednt concern yourself with the details of your investments, this is handled by the fund manager who is reasonable for ensuring that the balance across all investments is reasonable.

The balanced fund, I guess, is more prescriptive in where it invests ensuring that each geography receives an appropriate level of attention whereas the opportunity fund enables the manager to invest wherever in the world he sees the best chances for growth.

For pension investing risk is normally handled by life-styling whereby long term better performing volatile equity invests are replaced by less volatile but poorer performing bonds and cash as you approach retirement. In the early days performance is more important than risk whereas at the end of your working life you are more concerned that a short term fall in values doesnt impact your retirement plans.

dunstonh

So, only 14.6% outside of equities and money markets in this allegedly lower-risk investment -- very small compared to the 40% recommended by "Ultimate Buy and Hold". Why so low?

It is not a lower risk investment unless you put it in context. On our scale it is 7 out of 10 (most balanced managed funds fall under 7 and 8 - although the scale is weighted so the volatility levels effectively give more "lower" risk ratings than medium or higher risk).

Most will use volatility as a key risk indicator. You can have funds with identical sector allocations but different investments within those sectors and have a very different volatility level.

Also, lower involvement means it needs lower work from you.

And why the bonds component in both funds is so low compared the "Ultimate Buy and Hold" recommendation?

Buy and hold is a flawed concept. No sensible investor would buy and hold. If the global economy was stable and never changed and companies never changed and interest rates never changed and fads never changed etc etc then buy and hold would work. However, nothing stays the same and we have booms, busts etc and allocations change to suit that.

Also, if you bought on a 60/40 basis as that suggests then it would go out of sync. It could end up 80/20 over time.

redonion

Linton wrote: »

"Low involvement" doesnt mean low risk.

That is true, but I did not intend to say that it does. Instead, I was comparing "Opportunity" and "Balanced" funds (I just fixed a typo in my original post where I mentioned "Balanced" twice instead of "Balanced" and then "Opportunity"). "Balanced" is intended to be lower risk. "Opportunity" is intended to be higher risk. (gah, just had to edit *that* to switch "higher" and "lower"!)

The balanced fund, I guess, is more prescriptive in where it invests ensuring that each geography receives an appropriate level of attention whereas the opportunity fund enables the manager to invest wherever in the world he sees the best chances for growth.

(S)he sees the best chances for growth in Europe and the USA? Well, maybe so, I suppose...

redonion

dunstonh wrote: »

It is not a lower risk investment unless you put it in context. On our scale it is 7 out of 10 (most balanced managed funds fall under 7 and 8 - although the scale is weighted so the volatility levels effectively give more "lower" risk ratings than medium or higher risk).

Well, the context that I gave for the higher-risk investment was the lower-risk investment, and vice-versa. But I assume you're making a point about the relation of both of these funds to the rest of the market. (and I guess you're saying that on your scale 10 is low-risk and 1 is high-risk?)

Most will use volatility as a key risk indicator. You can have funds with identical sector allocations but different investments within those sectors and have a very different volatility level.

That's a fascinating question, really: is there really any relationship at all between, say, 1 year volatility and 30-year risk? Crucially, what reasons are there to believe that there is?

Also, lower involvement means it needs lower work from you.

Both funds fall into their "Low Involvement" category.

Buy and hold is a flawed concept. No sensible investor would buy and hold. If the global economy was stable and never changed and companies never changed and interest rates never changed and fads never changed etc etc then buy and hold would work. However, nothing stays the same and we have booms, busts etc and allocations change to suit that.

I can't disagree with that (though it does seem very plausible that many strategies involving frequent changes are worse than one in which you simply buy and hold for most of the pension lifetime).

Also, if you bought on a 60/40 basis as that suggests then it would go out of sync. It could end up 80/20 over time.

Good point.

Linton

redonion wrote: »

Well, the context that I gave for the higher-risk investment was the lower-risk investment, and vice-versa. But I assume you're making a point about the relation of both of these funds to the rest of the market. (and I guess you're saying that on your scale 10 is low-risk and 1 is high-risk?)
....

Wrong way round - 10 is very high.

dunstonh

Well, the context that I gave for the higher-risk investment was the lower-risk investment, and vice-versa. But I assume you're making a point about the relation of both of these funds to the rest of the market. (and I guess you're saying that on your scale 10 is low-risk and 1 is high-risk?)

No. The scale is 1 = cash and 10 = highest risk for funds (experienced investor options not factored into the scale. e.g. VCTs etc)

That's a fascinating question, really: is there really any relationship at all between, say, 1 year volatility and 30-year risk? Crucially, what reasons are there to believe that there is?

You need to look at the retail consumer market, complaints and the regulator. There are a good many people out there that complain if their money loses 40% of its value in 18 months. Even if it doubled previously and long term offers greater potential. They lack the skills to understand the long term nature and are too short term in their views. So, the basic risk scales issued by providers tend to focus on that because they are catering for the basic consumer, a regulator that is inconsistent in its views and an ombudsman that assumes that the average UK consumer is cautious unless shown otherwise.

It is important to separate risk and potential. Just because a fund is likely to give a better return over the long term, does not mean it is suitable for an individual if that individual is going to panic when they lose x% and then pull it out at a loss. Just look at anyone who says they will never invest in the stockmarket again because they lost money. That is someone who didnt know what they were doing and invested above their risk profile.

Std Life stakeholder is a basic product, offering basic funds and retailing to a basic client. Which may well frustrate those that have to use it who are not basic investors. However, that is the position of a stakeholder.

grey_gym_sock

redonion wrote: »

That's a fascinating question, really: is there really any relationship at all between, say, 1 year volatility and 30-year risk? Crucially, what reasons are there to believe that there is?

well, the main reason is that we can measure past volatility. if that isn't a good indicator of risk, what else have we got?

more seriously, i think volatility tells you something about risk, but not everything.

redonion

dunstonh wrote: »

It is important to separate risk and potential. Just because a fund is likely to give a better return over the long term, does not mean it is suitable for an individual if that individual is going to panic when they lose x% and then pull it out at a loss. Just look at anyone who says they will never invest in the stockmarket again because they lost money. That is someone who didnt know what they were doing and invested above their risk profile.

I see. Seems to me the notion of risk profiles that's convenient for the industry is misconceived as far as customers go, because it's not really clear that the choices a lot of people are making are between low risk and high risk at all -- more between good investment decisions and bad ones. Unfortunately, I have no reason whatsoever to think I'm capable of making good investment decisions

Std Life stakeholder is a basic product, offering basic funds and retailing to a basic client. Which may well frustrate those that have to use it who are not basic investors. However, that is the position of a stakeholder.

As you likely realise, they do offer more focused funds that you can pick-and-mix too (all at 1% -- in the scheme I've got access to, anyway).