Understanding risk in 3DJuly 23, 2014 - 13:55
The IPR analysis on the CitiFirst UK Autocall Fund (Share Class A2) and the Rainbow Supertracker are now available on the CUBE websote. These analysis, which is updated weekly, allow you to look at risk in three different ways:
1. We calculate the volatility of the returns that you can expect. (We use the worst 10% of returns to calculate this figure as most people use it as a proxy for riskiness). This risk figure is itself presented in a number of ways:
a. The volatility figure itself - many adviser will simply look at this figure
b. We rank all products on the 1 – 7 risk score used by funds using a method adapted from the European regulator’s recommended methodology
c. We map our risk scores outcomes to a 1 – 10 scale using the same volatility buckets as popular risk scales used by the majority of UK financial advisers
2. We show the chance that an investor will lose money over the remaining term, and the expected pay-off of there is a loss. This allows you to evaluate both the chance and possible scale of any loss. This is based on the current price of the investment and the current levels of the underlying indices
3. We also show average of the worst 10% of returns you can expect - another way to look at how bad things might be in negative market scenarios
Considering Cube's output for the Rainbow Supertracker and the UK Autocall Fund we think that most advisers will want to use a combination of all three measures when assessing the suitability of a product; the volatility number is probably a good match for an investor’s attitude to risk, while the chance of loss, the expected payoff, and the average of the worst 10% are a better illustration for gauging an investor's capacity for loss.
Looking at the Rainbow Supertracker as an example:
- The volatility is 17%, so close to an equity fund. This is reasonable because we see this product as a replacement for an equity investment
- The product only has a 2.1% chance of loss. This is very low. But if there is a loss the loss will be large. The expected payoff is 43.7%. An equity fund (including dividends and fees) by comparison has a 18.7% chance of loss over a 6 year period, and the final payoff if there is a loss is just less than 80%
- The average of the worst 10% is -2.7% per annum, again a very low number; for an equity fund we see this as -6.2%
So what does this tell us?
Well it highlights why we like the Rainbow Supertracker right now. The volatility is similar to an equity fund, but the downside characteristics of this product are very different. The FTSE-only soft protection offers significant benefits in terms of a much lower chance of loss.
David has been involved in equity derivatives, equity structuring and the structured product market for over 25 years. Before setting up CUBE in 2013 David worked at J.P. Morgan, Barclays and RBS. David has worked with and for retail product providers, discretionary managers and institutional investors.