Managers who aim to shoot the lights out by taking on a higher level of risk than clients expect are giving the entire industry a bad name, according to Mike Webb, chief executive of Rathbone Unit Trust Management. 

Webb believes managers should be made to set targets for the volatility of their funds as well as the returns, which he hopes will be the case post-RDR.

"The whole industry is damaged by the outlying funds in the mixed-asset sectors, which take on more risk than the average funds in some sectors usually seen as riskier," Webb said. 

"With RDR coming into force, every single adviser has to understand his clients’ risk profile and plan in accordance with them, so you cannot afford to have a fund which is changing its volatility." 

"Risk-targeted funds will become most important drivers for those who want a core holding for a portfolio and for those IFAs who are outsourcing fund management."

Webb is scathing about the culture of chasing top-quartile returns, saying the regulatory enforced focus on risk would bring this to a welcome end. 

"When you ask clients what matters to them in terms of their portfolio’s performance, you find whether the fund is first or fourth quartile is irrelevant, but what matters is whether the targets you have agreed with them have been met," he commented.

"A focus on producing the best returns is not necessarily what investors want." 

A number of industry insiders have hit out at managers who have taken on too much risk in recent months. A recent FE Trustnet study revealed that nine funds in the IMA Mixed Investment 20-60% Shares sector have breached their 60 per cent equity limit. 

Darius McDermott, managing director of Chelsea Financial Services, is slightly cooler on the idea of including volatility in a benchmark. 

"If you look at the trend of firms launching funds with these benchmarks you can see it is a popular idea, but I’m not convinced it will be appropriate for all investors though," he said. 

"I like to think that our clients have a slightly higher tolerance to funds going up and down as they understand that the value of investments can change quickly, but for the investors with a cautious risk profile it may well be a good idea." 

FE Alpha Manager David Coombs, head of multi-asset investments at Rathbones, claims risk has become a preoccupation with investors who don’t feel comfortable second-guessing the market in the current environment. 

"Every conversation I have right now is about risk," he said. "Three years ago everyone wanted to ask you about your returns, now they want to know your volatility." 

Coombs heads the team on Rathbones' three multi-asset multi-manager portfolios, each designed to appeal to an investor with a different risk profile. 

Asset allocation is the most critical aspect of managing risk in Coombs' view, but he believes the usual method of categorising it is misleading. 

He and his team divide assets into three kinds: liquid, which are sensitive to market movements; alternatives, which are those with a correlation of less than 0.4 to equities – meaning when equity markets go down by one per cent they go down by less than 0.4 per cent; and Beta assets – those that have more than a 0.4 correlation to equities. 

Coombs says trying to balance a portfolio’s risk profile can lead to counter-intuitive investments.

"A lot of our funds are volatile but with a low correlation to equities," he explained. 

Diversification is particularly difficult with what Coombs describes as the manipulation of bond yields by central banks. 

"The gilt yield is not a real yield so we can’t use it to price asset allocation. Some people say that property provides a good yield compared to gilts, but we won’t touch it because we don’t believe the gilt yields," he said. 

"Gold used to be a good diversifier, then in July 2011 it started to become correlated to equities and so we sold. Until a few weeks ago equities were moving in sync with gold and we are now looking to get back in."

"Sovereign gilts we think have no value, but we did buy 30-year Treasuries and gilts in March, purely for the lack of correlation. On these long time frames the bonds are volatile but not correlated," he finished.