What do FE Risk Scores tell me?
FE Risk Scores define risk as a measure of volatility relative to the FTSE 100 index, which has a risk rating of 100, and rebased to sterling. Instruments more volatile than the FTSE 100 have a score above 100 and vice versa giving a reliable indication of relative risk. Most volatility measures are based on absolute risk.
Because the absolute levels of risk in markets naturally ebb and flow, risk levels can appear to change without there being significant changes to the fundamentals. So these changes could spuriously encourage people to sell or acquire particular investments.
Relative risk is not affected in the same way, and is likely to provide a clearer indicator of important risk changes. Scores are recalculated weekly on a rolling three-year total returns basis. Most funds would fall between one and 150 with direct equities scoring above 100 and pure cash = zero.
Funds need an 18 month track record to be eligible for a Risk Score. FE has introduced a decay factor, or lambda*, so that older values carry less weight and that this means that the scores are more responsive to recent events, without being excessively sensitive. FE Risk Scores are designed to be a simple and intuitive tool enabling investors and advisers to measure the risk of an entire portfolio or its constituent elements. Indeed, a portfolio's overall risk can be compared to holdings within it to assess whether benefits have been gleaned from diversification.
FE's new risk score calculation has been added to fund, sector and FE AFI factsheets as well as portfolio scans, custom table reports and filters.
• are a measure of relative rather than absolute risk
• set in relation to intuitively understandable yardsticks
• responsive to recent events, without being excessively sensitive
*Lambda indicates the rate at which something decays, in proportion to its value. FE has used a lambda of 0.98 so less recent data has lower weighting at a decay rate of 2% per week. Why would I use FE Risk Scores?
FE Risk Scores, in contrast to many other risk measurements, offer the following attractions: they are:
C. cover nearly all investment types in one measurement system
D. are sensitive to market conditions
E. are a measure of relative rather than absolute risk, which means that ones’s perception of an instrument’s riskiness is not clouded by the general ebb and flow of volatility in markets How are FE Risk Scores calculated?
The scoring system uses a minimum of 18 months and a maximum of 3 years of weekly total returns to measure the volatility of an instrument relative to the FTSE100. All values are rebased to Sterling, for UK Risk Scores. But less weight is given to the older returns, so that the score is more sensitive to recent events, but not excessively so Why is the FTSE 100 being used as the reference point? Why not the FTSE All Share?
Any recognised measure of general investment market conditions would do. But since the reference point is set at 100, it just seemed more natural to use the FTSE100, in a UK context. When Risk Scores are calculated for other parts of the world, more relevant local reference points will be used, and the data will be rebased to local currencies. Typically, what can I expect FE Risk Scores to show me? (examples – eg cash scores likely to be lower than equity)
As can be seen, the FTSE100 will always have a score of 100. The other fixed reference point is pure Cash, which will have a score of zero. Mutual funds will mostly have a score between 1-150, whereas equities will generally be above 100, sometimes considerably above 100. What instruments are FE Risk Scores available for?
In the UK, the following instrument types will be Risk Scored – UK Equities, UK Unit trusts and OEIC’s, UK Life and Pension Funds, Offshore funds for sale in the UK, ETF’s and VCT’s, as well as Fund sector averages and Indices. In addition any portfolio can be Risk Scored. How do I use these scores in tandem with FE’s other fund and manager ratings?
FE Risk Scores are a free-standing risk measure, which do not directly relate to our other ratings. But in the coming months we will be bringing out further tools to let investors express their risk position in relation to Risk Scores, and then let them look at this in relation to the Risk Scores of their portfolios and holdings.
In addition we will be extending this to help people build better portfolios, by combining the selection of quality funds (using our FE Crown and Alpha Manager ratings), with the appropriate positioning of risk (using the FE Risk Scores). What are the maximum and minimum scores available?
The FE Risk Score scale starts at zero, and in theory has no upper limit How often are FE Risk Scores updated?
FE Risk Scores are recalculated weekly. What does it mean if a score changes?
FE Risk Scores are unlikely to experience big changes week by week. That is because, even though more weight is given to recent events, returns going back up to 3 years contribute towards the score.
Nevertheless, changes over time, reflecting a change of riskiness relative to the large cap market, can be significant.
Certainly one should review the trend relative to other similar funds, and the asset class of that fund, to consider whether any action should be taken. We will shortly be introducing the ability to pull up a small graph of an FE Risk Score over time, by clicking on the score icon itself.