Can risk targeted funds be compared with their return focused peers?

Mike Turner – Assistant Research Manager for Funds and DFM

Historically, advisers have used sector classification organisations such as the Investment Association to narrow down the fund universe into more manageable peer groups. With the increased presence of multi-asset risk targeted funds over the past few years, advisers are faced with new challenges in the way they narrow funds down into like-for-like peer groups.

This article explores current sector comparisons between risk targeted and return focused funds and identifies where risk targeted fits into today’s sectors.

The above table shows the three-year Sharpe Ratio as an average for the return focused funds within the Flexible and Mixed Investment sectors versus the three-year Sharpe Ratio as an average of the risk targeted funds within those sectors.

As would be expected, there is little difference between the risk targeted sector averages and return focused sector averages as the asset allocation of funds within the Flexible and Mixed Investment sectors will be similar due to sector constraints.

Although the asset allocations for risk targeted and return focused funds can be in line with one another and therefore categorised into the same sector, the objectives are different. Risk targeted funds are focused on delivering an outcome based on targeting specific volatility ranges. The manager's mandate is to manage the fund within a volatility range which is different to return focused mandates which aim to deliver capital growth using asset allocation and fund selection.

From the data above we can see that there is a significant number of risk targeted funds within the Unclassified sector and some in Specialist. One of the challenges facing these sectors is that the strategies of funds within these sectors can vary significantly from one fund to another, meaning that peer comparisons aren’t meaningful.

Another aspect to consider in regard to comparing risk targeted funds is whether to compare risk targeted funds or risk targeted fund families. 

Risk targeted funds are usually launched as a family, with each fund within the family having the same team and process behind it but targeting a different volatility band. By grouping risk targeted funds into families, comparisons of the family as a whole with other risk targeted families becomes possible. Comparing the volatility spread across the family and whether the fund manager of a family is delivering volatility in line with the marketed stepped risk progression are both examples of comparisons that can be made when evaluating risk targeted funds on a family basis.

Defaqto has created the below infographic to illustrate the different areas of the landscape, grouping risk targeted funds into families and categorising risk targeted families as a peer group separate to return focused.



In conclusion, risk targeted funds operate on a different mandate to return focused funds and aim to achieve a specific outcome, which is to target a defined volatility rather than a certain level of return. Therefore, risk targeted funds serve a different purpose to return focused funds.

As a result, the Investment Association has issued a consultation on the evolution of the Investment Association classification system to address such challenges.