Multi-asset risk bound fund families: how to rate and select them

Transcription

1 Multi-asset risk bound fund families: how to rate and select them March 2018 Sponsor Accredited by

2 Contents Introduction 3 Learning objectives 4 PART 1 Market backdrop 5 Understanding the universe of multi-asset funds 6 Risk bound fund families 9 A rating framework for selecting risk bound funds based on quality 10 Selecting risk bound funds based on suitability 12 Benefits of using risk bound fund families 15 Test yourself for CPD 16 Learning objectives 17 PART 2 Prudential Dynamic and Dynamic Focused Portfolios 18 Prudential Dynamic Portfolios 21 Prudential Dynamic Portfolios fund family performance 28 Prudential Dynamic Focused Portfolios 29 Prudential Dynamic Focused Portfolios fund family performance 36 Charges and investment method 37 How can the funds be accessed? 38 Conclusion 39 Appendix A: moving between risk bound funds within the same family (decreasing risk) Appendix B: moving between risk bound funds within the same family (increasing risk) Nothing in this document constitutes financial, investment or other professional advice, and relevant advice should be sought prior to any financial or investment decision being made. Defaqto will not be responsible or liable for losses or damages of any kind which arise in relation to the use of, reliance on or inability to use this document and/or its contents or any other matter relating to this document and/or its contents to the fullest extent permitted by law. This document may include forward looking statements or projections that are based upon Defaqto s current opinions. Actual performance may differ from that anticipated in the forward looking statements, and Defaqto will not be responsible or liable for losses or damages of any kind which arise as a result of the reliance on such forward looking statements or projections. Defaqto does not guarantee and accepts no responsibility or liability for the accuracy, completeness or reliability at any time of the contents of this document. Unless otherwise stated, Defaqto retains copyright in and/or has a right to use all contents of this document (including text and graphics) and such contents shall not be copied, distributed, extracted or modified without the express prior written consent of Defaqto unless for private, non-commercial use.

3 Introduction In recent years, with the market volatility we have seen, there has been a shift in investors primary focus from being on return to being on risk. This document will take a closer look at the multiasset funds universe and in particular risk bound funds. These funds exist as families normally four or five funds run by the same fund management team and following the same investment process but with expected return and risk for each fund increasing across the family. Risk bound funds aim to maintain a risk level, or match a specific profile, over time. Doing this successfully requires the fund to adapt to market movements by adjusting the asset allocation. Even with the volatility of the market the risk profile of a risk bound fund should remain fairly consistent, enabling advisers to align the risk attitude of their clients to the funds. An adviser making decisions about which investment proposition is suitable for a client s needs will initially have undergone a lengthy process of discovery with regard to their client. Specifically, they will look at the client s objectives and their attitude to risk. They will then research how best to meet the client s needs. When looking at investment solutions, many advisers will look at collective investment scheme solutions and specifically multi-asset funds. Patrick Norwood Defaqto Insight Analyst (Funds) pnorwood@defaqto.com We have split the document into two parts: Part 1 Overview of multi-asset risk bound fund families Part 2 An example of risk bound fund families We provide a market backdrop, an overview of the multi-asset fund universe and a framework for rating and selecting funds and fund families from both a quality and suitability point of view. This section is accredited for continuing professional development (CPD). We look at Prudential s Dynamic and Dynamic Focused ranges as examples of risk bound fund families and consider the investment process behind them, the asset allocation, performance and charges for each fund and how the fund families can be accessed. 3

4 Learning objectives This case study is accredited by the CII/PFS and CISI for up to 30 minutes of structured CPD. Having read this document, you will be able to: 1 Identify the different ways in which the multi-asset fund universe can be broken down 2 3 Understand what risk bound multi-asset funds are, how they work, how they can be used and how their sub-set risk targeted market has grown over the last few years Understand how risk bound funds can be rated from both a quality and suitability point of view 4 Understand the benefits of risk bound funds to advisers and their clients Acronyms ACD AMC AUM DNA LGIM LTIS MAGIM NURS OCF OEIC PPMG SAA TAA UCITS Authorised Corporate Director Annual management charge Assets under management Data numerical analysis Legal & General Investment Management Long Term Investment Strategy M&G Investment Management Non-UCITS retail scheme Ongoing charges figure Open-ended investment company Prudential Portfolio Management Group Strategic asset allocation Tactical asset allocation Undertakings for the collective investment of transferable securities 4

5 Part 1: Market backdrop Equity markets remained optimistic over most of 2017 driven mainly by positive economic data and strong corporate earnings statements. Negatives such as the threat of North Korea and developments in Catalonia were shrugged off. The prospect of possible tax reform in the US was also seen as another reason for optimism. UK equities rose but generally by less than the other major markets. Inflation has continued to increase while economic data has indicated modest growth in the economy. At the end of 2017 there was finally some progress in the Brexit negotiations. Of the main equity markets, Japan s was one of the strongest in the second half of 2017, as it benefited from the large victory of the ruling coalition in the October election. This win gave Prime Minister Abe and his ruling Liberal Democratic Party a fresh mandate for economic stimulus, including monetary policies which have been supportive for their economy. Emerging market equities, led by Asia, also grew strongly compared to other markets, due to a combination of the following: rising oil prices, many emerging market currencies weakening against the US dollar and interest rate cuts in some countries. However, many commentators now see equities as overvalued, therefore equity returns could potentially be lower over the next few years than historical averages. The second half of 2017 was also positive for bond markets, with corporate bonds in general outperforming government bonds. The US Federal Reserve (Fed) began to reduce the amount of stimulus it was providing through quantitative easing, although this has had minimal impact as the move had already been widely communicated to the market. The European Central Bank announced that it would be reducing its asset purchases, but extending the programme for a few months longer. Bond yields, though, are low by historical standards, so bond returns could well be lower over the coming years. In November 2017, the Bank of England joined the Fed in the process of normalising interest rates, with the Bank Rate being increased from 0.25% to 0.5%. In addition to the above valuation concerns, possible downside risks to markets include: The emergence of higher inflation, particularly as full employment is reached in the US, UK, Japan and much of Europe Policy-makers raising interest rates by too much too soon or not quickly enough Tax reform in the US failing Political uncertainty With potentially lower returns across most of the traditional asset classes, people will need to consider a combination of saving more, working longer and/or investing in riskier assets. Multiasset products and solutions that combine risks intelligently and consider loss mitigation should continue to increase in popularity, and costs will also become more important when equity markets were rising 15 20% a year, as they did in the 1980s and 1990s, fund managers could get away with charging 1.5% or even 2% ongoing charges (OCFs). In this new era of lower returns, however, with charges forming a higher proportion of returns, funds with OCFs of less than 1% will probably be much more appealing to investors. MiFID ll came into effect at the start of In essence it aims to increase investor protection by aligning financial services regulation across the EU. With good practice in financial services regulation largely originating in the UK, it is believed to be unlikely that Brexit will have an effect on implementation of the new rules. What is expected as a result of these rules is: More governance Greater transparency Standardisation of key information Greater supervisory powers including intervention pre and post sale While most new legislation can be painful in terms of cost and understanding, there is a benefit to those who are endeavouring to compare propositions. 5

6 Understanding the universe of multi-asset funds Identifying the appropriate strategy Multi-asset funds come in various forms. Our quadrant diagram below offers a framework to help advisers identify the key investment characteristics and the positioning of each multi-asset class investment fund. Risk targeted Risk focused Risk bound Return focused Investment style Active Traditional Alternative (and traditional) Asset type Multi-asset funds Investment method Passive Active/Passive blend Management approach Single-manager (direct) Multi-manager Manager of managers Fund of funds 6 Fettered Unfettered

7 As can be seen, Defaqto s framework focuses on four key themes: 1. Investment style Multi-asset funds can be either: Risk bound existing as families (sets of funds), with either each fund in the family targeting a certain numerical level or range of risk, and return being the secondary aim (risk targeted); or with each fund having more emphasis on return but being constrained by risk in some way, eg through the Investment Association sector it sits in (risk focused) Return focused funds primarily aim to outperform a benchmark (ie FTSE 100) or a sector (ie UK All Companies) with risk being the secondary consideration Return focused funds are useful if an investor is trying to achieve a certain level of growth over time or a particular goal in terms of amount of money. Risk bound funds, the main focus of this case study, are discussed in more detail in the next section. 2. Management approach Multi-asset funds can also be either: Single-manager one fund manager or team manages all the investments in the fund Multi-manager different fund managers are used across and sometimes within the various asset classes The rationale for multi-manager investing is that no one manager can be the best across every single asset class and, instead, one should seek out a specialist manager for each different area. The disadvantage of this approach is that by employing other managers, an extra layer of fees will be introduced, making multimanagers more expensive on average. Multi-manager funds may be either: Manager of managers a mandate will be set up with the sub-fund manager and run on a segregated basis Fund of funds the multi-asset manager is buying and selling all or part of its underlying funds Fund of funds may be either: Fettered the multi-asset fund manager can only use funds from elsewhere within their organisation The big advantage of unfettered is that the opportunity set is much larger, not only in terms of funds but also investment styles and strategies, with the result that the manager should be able to achieve greater diversification. With fettered funds, however, costs will usually be lower, and the multi-asset manager will have more detailed access to the underlying fund managers. Also, monitoring fewer managers allows for greater concentration on the individual manager. 3. Asset type Multi-asset funds may be either: Traditional asset funds investments are long-only and in the traditional asset classes of equities, bonds, cash and property Alternative (and traditional) asset funds investments are a combination of traditional asset classes and alternative assets, such as private equity and infrastructure Alternative asset classes offer greater potential for higher returns and diversification; they can also be more risky and expensive, lack liquidity and be less transparent 4. Investment method Finally, multi-asset funds can be: Active the underlying managers attempt to generate returns in excess of the stated benchmark/index, although there is the risk of them underperforming it Passive the underlying funds simply aim to track the benchmark/index and will normally be much less expensive. Allocation between the funds will be made on a long-term basis using a strategic asset allocation (SAA) and there is no short- or medium-term active allocation (short- to medium-term here means an investment horizon of roughly one to five years and would involve tactical asset allocation (TAA)) Blended significant positions can be held in both active and passive funds and/or the fund manager is able to invest in each. In addition, this includes funds holding entirely passive funds but where the fund of funds manager has freedom to make TAA weightings Unfettered funds from any firm may be used 7

8 Evolution of investment solutions Investment solutions have evolved considerably over the last couple of decades, in several different ways. As already mentioned, there has been a shift in the focus from being on return to being on risk, while the number of asset classes available has increased, to include alternative assets. In addition, portfolio construction used to focus almost exclusively on asset class diversification. Nowadays, however, allocation is often across the underlying risk (or other) factors. Also, the use of derivatives and other similar instruments has increased. 8

9 Risk bound fund families In the case of risk bound, there are on average four or five funds in a family, with each fund in the family being used by different investors, depending on their risk tolerance and the point in their investment lifecycle. In other words, younger investors in the accumulation phase would be expected to use the higher risk funds in the family, with their corresponding higher levels of expected return, while older investors approaching retirement or already in the decumulation phase will tend to use the lower risk funds, accepting their probable lower expected returns. One advantage of risk bound fund families, therefore, is that if the investor s circumstances change then they can simply move up or down the risk scale accordingly to a different fund within the same family that is more suitable. The adviser will have a reduced amount of due diligence to carry out in terms of finding a new proposition as this will have been done at the start (this is illustrated using examples in the Appendices). As a result, the investor could be in the same fund family for most if not all of their lifecycle. The funds within each family will usually be managed by the same person/team and follow the same investment process, with the different levels of risk being achieved mainly through varying the asset allocations across the family but also, to a lesser extent, by selecting different underlying funds or managers. The risk targeted fund market grew strongly in the years immediately before and after the UK retail distribution review of 2012/3 as advisers focus shifted to client suitability and investment outcomes (see Chart 1), with the adviser determining a client s attitude to risk and their capacity to accept losses and then recommending appropriate solutions based on those measures. The other reason for the strong growth in the risk targeted market in the latter parts of the last decade and early years of this decade was the huge credit crunch related market volatility observed around This was seen by many as a watershed where investors primary concerns shifted from generating the best return possible, to risk and protection of capital. In the last three or four years, however, this growth has slowed, most likely due to pension freedom reforms, which mean that retirees are no longer forced to buy an annuity. As a result, advisers and providers have become more focused on incomeproducing outcomes, in the retirement segment of the market. Chart 1: Growth in the risk targeted market Number of families Number of family members Source: Defaqto 9

10 A rating framework for selecting risk bound funds based on quality Defaqto introduced Diamond Ratings to help advisers and investors navigate the fund universe by providing an independent assessment of where funds and fund families sit in the market. In scoring multi-asset and other types of funds, we apply a data numeric analysis (DNA) methodology, with each fund feature and performance attribute being scored from 1 to 5, where 5 indicates the best possible characteristic (top quintile) and 1 indicates the worst characteristic (bottom quintile). We divide funds into different universes when doing this, so that we are comparing like with like. The sum of the individual DNA scores across the range of fund features and performance attributes provides an overall score, which we use to rank each fund or fund family within its respective universe and then give it a Diamond Rating of 1 to 5. Under our standard methodology for rating risk bound fund families (which applies to those with five or more years of performance data), all families are rated on their risk adjusted performance, as measured by Defaqto s proprietary risk adjusted alpha. This is defined as: The fund s actual return The return expected for the amount of risk taken over the measurement period Expected return is determined from Defaqto s ten risk levels (see next section) each level will have an associated volatility and return. The risk versus return of the ten risk levels is plotted on a chart and a curve of best fit is produced. From that curve, there will be an expected return corresponding to a given volatility, and the fund s actual return will either be above or below that. The average risk adjusted alpha is taken across the family. We then look at family risk shape as part of our Diamond Rating for risk bound fund families, which consists of three different proprietary measures of how the funds in the family behave in relation to one another: Spread the range of risk available in the family of funds, calculated as the difference in risk between the maximum and minimum risk fund, with a wider spread being seen as better Consistency how even the increases in risks are when moving between one fund and the next, calculated as the variance of these changes in risk, with a lower variance (ie more even steps in risk) being rated as better Shape according to investment theory, if investors take extra risk, they should be rewarded with higher returns, at least over the medium to long term. Shape measures the conformity of the family of funds to this expected positive relationship between risk and return, with a closer fit to this pattern receiving a higher score. The weightings on each of these are doubled to give performance and risk shape a higher impact on the overall rating. 10

11 Newer fund families Where there is no performance data, or data of less than a year, we instead rate the fund family through at least one due diligence meeting with the fund manager on the following five criteria: Business strength including ownership stability, financial strength, ability to deal with business growth and key person risk Staff quality experience and skills of the team members, in particular the key decisionmakers, team stability, how well the team is incentivised and staff turnover Investment philosophy is there anything unique about the manager s beliefs and philosophy? Can they be translated into excess returns (alpha)? If so, in what type(s) of market are they likely to do well? Additional features Investment process is it clear, understandable, well thought out and consistent with the philosophy? How does the manager research and select investments? How do they put portfolios together and what are their sell disciplines? How do they analyse and manage risk? Research capability level and type of resource, in particular the size of the research team Where there are between one and five years of performance numbers, this part of the ratings will be a mix of the performance/risk shape and the due diligence scores. Our Diamond Rating scoring methodology also takes into account the following additional features, and these are looked at in the same way regardless of the age of the family: Number of funds in the family more funds in the family is seen as better, as it means that advisers can more closely align a fund s objectives to the needs of a particular client Family assets under management (AUM) needs to be above a minimum level to be economically self-sustaining, plus size of AUM is an indicator of total resources available to the funds Manager tenure managers with greater experience of managing the fund family are a likely indicator of achieving the fund objectives in the future Ongoing fund charge a lower charge is less of a drag on performance Undertakings for the collective investment of transferable securities (UCITS)/Non-UCITS retail scheme (NURS) status funds that operate under a UCITS structure have greater controls over risk management and reporting Domicile funds registered within the UK will enable investors to access the Financial Services Compensation Scheme (FSCS) if necessary and avoid potentially complex tax implications These features receive no extra weighting when adding up their DNA scores, resulting in the overall Diamond Rating attribution in Chart 2. In this chart number of funds in the family, family AUM, manager tenure, UCITS/NURS status and domicile are grouped into other features. Chart 2: Diamond Rating attribution 7.1% 42.9% 35.7% Charges Other features Performance / due diligence scores Risk shape / due diligence scores 14.3% Source: Defaqto 11

12 Selecting risk bound funds based on suitability Defaqto researches funds and portfolios in detail to assign them a Defaqto Risk Rating, with each rating corresponding to a Defaqto Risk Profile. Defaqto s Risk Ratings allow advisers to assess multi-asset funds in terms of their risk and hence suitability for each client. These ratings are reached by: Looking at the fund s past volatility (standard deviation) of returns over 1, 3, 5 and 10 years, where that data exists Looking at the fund s projected volatility using its asset allocation and assumptions for the future returns, volatilities and co-movements of the asset classes it holds Discussing these numbers with the manager of the fund The perceived risk of each fund, normally the highest of the past and projected volatilities, is mapped onto a scale, where 10 is the most risky and 1 is the least risky, to give the fund its Defaqto Risk Rating. Defaqto risk profiling Advisers tend to undertake the following process in selecting a suitable investment strategy: 1 Understanding the client's objectives 2Defaqto Risk Profiles 3 Researching suitable funds or portfolios 12

13 Understanding the client's objectives To understand the objectives, the adviser needs to understand: Attitude to risk Required return Capacity for loss Agreed risk profile Attitude to risk is usually established through the completion of a psychometric questionnaire to determine the natural risk level on a scale of 1 to 10 where 1 is the lowest risk level and 10 is the highest risk level. Required return can often be the most dominant assessment criteria. How much will be invested, for how long? Is there a regular investment (how much and how often)? If the return (growth and/or income) required can be achieved by having to tolerate less overall volatility and risk, then there is no need to invest in a combination of assets beyond a particular risk level, even if the investor s attitude to risk indicates a higher level of risk would be acceptable to them. Capacity for loss was described by the FCA in March 2011 as the client s ability to absorb falls in the value of their investment if any loss of capital would have a materially detrimental effect on their standard of living. By defining a particular level of risk to take (and thus a commensurate combination of assets), one can assess whether the individual s financial situation can withstand the impact of a worst-case outcome, or a near worst-case scenario, based upon a given percentage probability of an event occurring. Once the natural risk level, required return and capacity for loss are understood, an agreed risk level can be set, also on the scale of 1 to 10, where 1 is the lowest risk and 10 is the highest risk. This may be different from the natural risk level and may also be different from other investment strategies, eg retirement saving compared to investing a windfall. This agreed risk level determines the Defaqto Risk Profile for that investment. Defaqto Risk Profiles Defaqto has created ten Risk Profiles which align to the attitude to risk levels. The higher the risk profile, the greater the potential return but also the increased potential losses. Each risk profile includes a description of a typical investor s attitude to investing and an overview of the typical asset allocation at that risk level. For each Risk Profile there is also an indication of the potential losses and gains over a 10-year investment term, to guide decisions. Researching suitable funds or portfolios Advisers can use the Defaqto Risk Profile to review any existing investments and research the market for suitable funds or portfolios. They can then make recommendations, either using these risk rated funds or portfolios, or construct a separate portfolio. It is worth noting that Defaqto s Diamond Ratings rate risk bound funds as a family, often looking at how the funds behave in relation to each other; therefore there will be just one rating for the whole family. Our Risk Ratings, however, rate each fund in the family on an individual basis, with each fund in the family almost always receiving a different Risk Rating. It is also worth remembering at this point the difference between risk targeted and risk rated funds risk targeted means a fund will aim to keep its volatility at a certain level or within a specific range, while risk rated means that a fund has been assigned a rating based on its perceived risk, either by ourselves or one of the other providers in the market. Therefore, a fund can be either risk targeted or risk rated, or be both or be neither. 13

14 Rory Percival report In late 2017, Rory Percival, former FCA technical specialist and now independent consultant, launched a risk profiling guide, having assessed six of the most popular risk profiling tools available in the market. Back in 2011, the FCA (or Financial Services Authority as it then was) found that 9 out of 11 of the market s key risk profiling tools were working inadequately. Percival highlighted three key findings from his new research: Risk profiling tools have come a long way since the 2011 guidance, with him not considering any of the six tools to be fundamentally flawed There were variations among the tools, particularly when it came to asset allocation. The asset allocation suggested in each tool varied significantly for each client s risk level Tools have become more integrated into the advice process since 2011, when they were more standalone The MiFID II regulation mentioned in the market backdrop section requires advisers to assess risk profiling tools to see whether they are fit for purpose, with the adviser then having to identify and mitigate any limitations they pose to the advice process. 14

15 Benefits of using risk bound fund families For the investor, the benefit of these types of funds is the simplicity of them, as it is possible for a client to invest in the same family of funds throughout their investment lifecycle. Younger investors in the accumulation phase would be expected to use the higher risk funds in the family, with their corresponding higher levels of expected return; while older investors approaching retirement or already in the decumulation phase will tend to use the lower risk funds, accepting their probable lower expected returns. For the adviser the benefit is that there is a reduced amount of due diligence to carry out in terms of finding a new proposition, as the majority of work will have been done at the start when researching the market and selecting the family. Risk bound funds offer investors access to disciplined, well-resourced and process-driven solutions to manage and meet client expectations and attitude to investment risk. Risk bound solutions managed with discipline lend themselves to maintaining alignment with a client s tolerance for loss, both now and in the future. In most cases it is possible for the client to invest in the same family of funds throughout their investment lifecycle. However, there can be significant differences in structure, process and other features across the various risk bound fund families in the market, so due diligence is still very important such funds need to be monitored to ensure that they are meeting their client s aims and objectives on an ongoing basis, as with any other fund. 15

16 Test yourself for CPD To assess your knowledge having read this publication, why not work your way through the following questions? All the answers can be found within the text. 1 What do the new MiFID II rules aim to achieve? 2 What are the advantages and disadvantages of multi-manager investing? 3 What are the advantages and disadvantages of fettered multi-manager funds? 4 What are the potential advantages and disadvantages of investing in alternative asset classes? 5 What is the main benefit for the adviser of their client staying within the same fund family when changing fund? 6 What is the main measure that drives a fund s risk rating? This publication is accredited by the CII/PFS and CISI for up to 30 minutes of structured learning. Name Signature Date CPD time recorded 16

17 Learning objectives This case study is accredited by the CII/PFS and CISI for up to 30 minutes of structured CPD. Having read this document, you will now be able to: 1 Identify the different ways in which the multi-asset fund universe can be broken down 2 3 Understand what risk bound multi-asset funds are, how they work, how they can be used and how their sub-set risk targeted market has grown over the last few years Understand how risk bound funds can be rated from both a quality and suitability point of view 4 Understand the benefits of risk bound funds to advisers and their clients Answers As a guide, your answers should include the following points: 1. More governance, greater transparency, standardisation of key information and greater supervisory powers 2. Advantage access to specialist managers; disadvantage extra layer of fees 3. Advantages generally lower cost, better access to the underlying managers and less managers to concentrate on; disadvantage much smaller opportunity set 4. Potential advantages higher returns and greater diversification; potential disadvantages more risky, more expensive, less liquid and less transparent 5. Less due diligence to carry out 6. Its volatility (both past and expected) 17

18 Part 2: Prudential Dynamic and Dynamic Focused Portfolios This part now considers Prudential s Dynamic and Dynamic Focused Portfolios and their potential suitability as risk bound solutions for clients. Each range consists of five portfolios, with expected risk and return increasing through the family. All of the portfolios aim to achieve long-term total returns (ie provide a combination of income and growth of capital) by investing mainly in collective investment schemes. The name of the portfolio indicates the range of exposure to equities, eg Dynamic will have between 10% and 40% invested in funds whose predominant exposure is to equities. The business and process behind the portfolios are described below. 18 Prudential Portfolio Management Group Prudential Portfolio Management Group (PPMG) was established as a standalone entity in 2014 and is responsible for approximately 184 billion AUM, as at 30 June 2017, across a range of multi-asset investment solutions and other Prudential products. The team is made up of around 80 members and is split into the following sub-teams: Long Term Investment Strategy (LTIS) Portfolio Management* Investment Research Manager Oversight Alternatives Business Development Risk Legal and Compliance *M&G Investment Management (MAGIM) is the investment manager for the Prudential Dynamic and Dynamic Focused Portfolios and they make the relevant adjustments to portfolios based on PPMG s recommendations. The authorised corporate director (ACD) of the Prudential Dynamic and Dynamic Focused Portfolios is Link Fund Solutions. The previous ACD, Capita Plc, sold its Capita Asset Services business to Link Administration Holdings Limited (Link Group). Investment process The process can be broken down into: Strategic asset allocation Tactical asset allocation Fund research and selection Portfolio management SAA The LTIS sub-team recommends the SAA for each portfolio. As part of this they develop their own capital market assumptions for the expected returns, volatilities and correlations of the various asset classes covered. They then use an in-house economic scenario generator, GeneSIS, to carry out stochastic modelling based on these assumptions, which involves a full range of possible future asset allocations being mapped out. The SAAs are determined from these potential portfolios using the following principles: Customer outcomes ensure that expected customer outcomes are mapped to the fund s objectives Tailored risk appetite all portfolios have a bespoke SAA that is designed for their specific needs, with any particular constraints taken into account Efficient risks and returns for a given risk appetite, PPMG will choose an asset allocation that generates the highest return

19 Consistency across fund ranges within the stated fund objectives and risk appetite, ensure a consistent SAA across funds with a similar risk appetite and other similar funds Other constraints any other constraints, such as cost and liquidity Once the optimised SAA for each portfolio is created, it is then approved by the Investment Committee and any portfolio changes are implemented by MAGIM. TAA TAA is where shorter-term house views around the SAAs can be reflected. These look 1 18 months ahead and are designed to focus on three types of mispricing opportunities: Macro relating to economic and market fundamentals Valuation based on PPMG s views of appropriate valuation parameters for the various asset classes and sub-asset classes they cover Behavioural resulting from short-term mispricing due to excess pessimism or optimism (leading to opportunity for reversal trades) or a clear trend that is likely to be sustained (leading to opportunity for momentum trades) Decisions can be based on a combination of more than one of the above and PPMG s TAA investment philosophy is not to take a position unless they believe the mispricing to be significant or the opportunity has a high likelihood of being rewarded. Fund research and selection The Dynamic Portfolios invest in active funds chosen by Morningstar, and the managers are generally external. There are some MAGIM funds throughout the portfolios, but these have also been selected independently by Morningstar. In the case of the hedge fund, infrastructure and private equity parts of the portfolios, PPMG has an in-house team of alternatives, specialists to source and recommend ideas for these (and the Dynamic Focused) portfolios. The Dynamic Focused range of funds is newer and designed to be lower cost and more competitive with their peer group of similar funds in the risk bound space. They feature: External passive funds for the equity part of the portfolios, as PPMG believes these markets to be large and efficient Active MAGIM funds for fixed interest and commercial property PPMG thinks that the cost differential between active and passive is lower with fixed income than equities, and value can be added in the credit and duration areas in particular As described above, external active funds sourced and recommended by PPMG for hedge funds, infrastructure and private equity Legal & General Investment Management (LGIM) is the manager for the passive equity funds. LGIM has total passive AUM of over 330bn (as at 30 June 2017) across several different asset classes and markets. They follow a pragmatic replication approach to passive investing rather than matching the exact weights of the index when buying and holding securities, LGIM instead attempts to minimise the impact of costs and looks for opportunities to enhance returns by allowing the weights to fluctuate within narrow bands and trying to anticipate index changes to avoid trading when conditions are less favourable. In addition, their scale should lead to efficiencies and cost savings. Portfolio management Portfolio management responsibilities can be split into the following areas: Keeping the funds in shape ensure the portfolios are managed in line with target exposures and limits while minimising cost and risk, adhere to agreed target TAA positions, and manage cash-flows and other fund dynamics TAA review tactical opportunities with teams across PPMG, determine changes in TAA positioning, and implement and monitor TAA exposures in conjunction with teams across PPMG Implementation ensure changes in SAA and TAA are implemented effectively and efficiently Operational management prepare and review trade instructions to minimise operational errors Portfolio monitoring review on an ongoing basis exposures, risks and performance in conjunction with PPMG Risk and Manager Oversight sub-teams and Morningstar (quarterly for the Dynamic Portfolios) Liquidity manage and report on this to ensure that outflows can be covered in stressed scenarios Each range and individual portfolio is now considered in more detail. 19

20 Defaqto risk assessment Table 1 demonstrates where the Prudential Dynamic and Dynamic Focused funds sit in comparison to each other and on the Defaqto risk assessment tool. Once an individual s attitude to risk, capacity for loss and required return have been considered, the agreed risk level tends to be most commonly graduated somewhere between levels 3 and 7. This is broadly the range and area of the market within which Prudential s funds, as listed below, are positioned to try to match investor needs. Table 1: Risk levels of Prudential s funds Defaqto Risk Rating Dynamic Portfolio Dynamic Focused Portfolio High Risk R I S K 10 DEFAQTO M A P P I N G R I S K 9 DEFAQTO M A P P I N G R I S K R I S K R I S K R I S K R I S K R I S K 8 DEFAQTO M A P P I N G 7 DEFAQTO M A P P I N G 6 DEFAQTO M A P P I N G 5 DEFAQTO M A P P I N G 4 DEFAQTO M A P P I N G 3 DEFAQTO M A P P I N G Dynamic Portfolio Dynamic Focused Portfolio Dynamic Portfolio Dynamic Focused Portfolio Dynamic Portfolio Dynamic Focused Portfolio Dynamic Portfolio Dynamic Focused Portfolio Dynamic 0-30 Portfolio Dynamic Focused 0-30 Portfolio Low Risk R I S K R I S K 2 DEFAQTO M A P P I N G 1 DEFAQTO M A P P I N G 20

21 Prudential Dynamic Portfolios Within the multi-asset universe Based on the quadrant multi-asset framework described earlier, Defaqto classifies Prudential s Dynamic funds as: Investment style Risk bound Asset type Traditional and alternative Multi-asset funds Investment method Active Management approach Multi-manager Fund of funds Mainly unfettered 21

22 Defaqto Diamond Rating The Dynamic family is more than five years old and has therefore been rated under our standard methodology. Two of the three risk shape scores are above average (compared to the rest of the universe). In terms of the additional features, this family has an above average number of funds in the range and large family AUM. The average OCF, however, is high in relation to the peer group. For each individual portfolio, the following pages show: its asset allocation, its Defaqto Risk Rating, the type of investor likely to invest in it (based on the Risk Rating) and its historical performance. 22

23 Dynamic 0-30 Portfolio ISIN code: GB00BF Fund description The fund aims for steady and consistent growth through a cautious approach to investing. The fund currently invests around 70% in a well-diversified portfolio of fixed interest securities and holdings of cash and money market instruments. The balance is invested in UK and international shares, property and alternative assets. Dynamic 0-30 allocation (%) UK Equity 7.55% Eur ex-uk Equity 3.07% US Equity 3.14% Japan Equity 1.62% Asian Equity 3.36% EM Equity 0.98% Property 7.35% IG Corp Bond 58.29% HY Corp Bond 5.42% Cash 6.20% Alternative Assets 3.01% Source: Prudential, as at 31 December 2017 Investors at risk level 3 tend to target a modest level of growth via a portfolio of mixed assets. Their portfolios will primarily be invested in fixed interest assets but also defensive equity and property so as to achieve relatively stable long-term returns. In the short term, they typically expect some volatility. Performance analysis Source of performance data: Financial Express (FE). Please remember that past performance is not a reliable indicator of future performance. The figures are intended only to demonstrate performance history of the fund over the period shown. They take no account of product or advice charges. The application of charges may impact the overall performance. The value of your client s investment can go down as well as up and the amount your client gets back may be less than they put in. 23

24 Dynamic Portfolio ISIN code: GB00BF Fund description The fund aims to achieve long-term total return (the combination of income and growth of capital) by investing mainly in collective investment schemes. Between 10% and 40% of the fund will be invested in schemes whose predominant exposure is to equities. Dynamic allocation (%) UK Equity 11.48% Eur ex-uk Equity 4.75% US Equity 4.70% Japan Equity 2.24% Asian Equity 4.71% EM Equity 1.60% Property 11.60% IG Corp Bond 44.59% HY Corp Bond 5.78% Cash 3.97% Alternative Assets 4.60% Source: Prudential, as at 31 December 2017 Investors at risk level 4 tend to target a moderate level of capital appreciation by investing in a multiasset portfolio. Their investments will be mainly in UK fixed interest securities, equities in particular UK equities and property. They typically expect a moderate amount of volatility. Performance analysis 24 Source of performance data: Financial Express (FE). Please remember that past performance is not a reliable indicator of future performance. The figures are intended only to demonstrate performance history of the fund over the period shown. They take no account of product or advice charges. The application of charges may impact the overall performance. The value of your client s investment can go down as well as up and the amount your client gets back may be less than they put in.

25 Dynamic Portfolio ISIN code: GB00BF Fund description The fund aims to achieve long-term total return (the combination of income and growth of capital) by investing mainly in collective investment schemes. Between 20% and 55% of the fund will be invested in schemes whose predominant exposure is to equities. Dynamic allocation (%) UK Equity 16.03% Eur ex-uk Equity 6.12% US Equity 6.24% Japan Equity 2.99% Asian Equity 6.75% EM Equity 2.18% Property 14.93% IG Corp Bond 31.29% HY Corp Bond 4.84% Cash 2.60% Alternative Assets 6.04% Source: Prudential, as at 31 December 2017 Investors at risk level 5 tend to target longer-term capital growth. Their investments will be mainly in fixed interest, equities with a UK focus and also some alternative asset classes, mostly property. They typically expect some volatility in return for the possibility of higher long-term returns. Performance analysis Source of performance data: Financial Express (FE). Please remember that past performance is not a reliable indicator of future performance. The figures are intended only to demonstrate performance history of the fund over the period shown. They take no account of product or advice charges. The application of charges may impact the overall performance. The value of your client s investment can go down as well as up and the amount your client gets back may be less than they put in. 25

26 Dynamic Portfolio ISIN code: GB00BF Fund description The fund aims to achieve long-term total return (the combination of income and growth of capital) by investing mainly in collective investment schemes. Between 40% and 80% of the fund will be invested in schemes whose predominant exposure is to equities. Dynamic allocation (%) UK Equity 20.65% Eur ex-uk Equity 8.03% US Equity 8.13% Japan Equity 3.72% Asian Equity 8.48% EM Equity 2.68% Property 17.30% IG Corp Bond 18.91% HY Corp Bond 3.72% Cash 0.85% Alternative Assets 7.54% Source: Prudential, as at 31 December 2017 Investors at risk level 6 tend to target a return using a portfolio with a higher equity content and a wider geographical spread. Their investments will be predominantly in UK and overseas equities, with an exposure to fixed interest and property in order to provide growth orientated diversification. They typically accept some volatility in return for the possibility of higher long-term returns. Performance analysis 26 Source of performance data: Financial Express (FE). Please remember that past performance is not a reliable indicator of future performance. The figures are intended only to demonstrate performance history of the fund over the period shown. They take no account of product or advice charges. The application of charges may impact the overall performance. The value of your client s investment can go down as well as up and the amount your client gets back may be less than they put in.

27 Dynamic Portfolio ISIN code: GB00BF232C79 Fund description The fund aims to achieve long-term total return (the combination of income and growth of capital) by investing mainly in collective investment schemes. Between 60% and 100% of the fund will be invested in schemes whose predominant exposure is to equities. Dynamic allocation (%) UK Equity 25.52% Eur ex-uk Equity 10.01% US Equity 10.07% Japan Equity 4.68% Asian Equity 10.32% EM Equity 3.31% Property 18.41% IG Corp Bond 6.89% HY Corp Bond 1.60% Cash 0.37% Alternative Assets 8.83% Source: Prudential, as at 31 December 2017 Investors at risk level 7 tend to target long-term capital growth by adopting a higher risk level. Their investments will typically be in UK and overseas equities, but also some alternative asset classes, for the purpose of achieving long-term capital appreciation. Performance analysis Source of performance data: Financial Express (FE). Please remember that past performance is not a reliable indicator of future performance. The figures are intended only to demonstrate performance history of the fund over the period shown. They take no account of product or advice charges. The application of charges may impact the overall performance. The value of your client s investment can go down as well as up and the amount your client gets back may be less than they put in. 27

28 Prudential Dynamic Portfolios fund family performance Prudential Dynamic Portfolios Source: Morningstar reinvested price series for P share class (Acc) rebased with Jan 2010 = 100 As can be seen and as would be expected, over the period these funds have existed, realised returns and volatility across the fund family increase with the amount of equities permitted in the portfolio. 28

29 Prudential Dynamic Focused Portfolios Within the multi-asset universe In terms of Defaqto s multi-asset framework, Prudential s Dynamic Focused funds are seen as: Investment style Risk bound Asset type Traditional and alternative Multi-asset funds Investment method Passive for the equity parts, otherwise active Management approach Multi-manager Fund of funds Mainly unfettered Fettered for the fixed interest and property parts Unfettered for the equity parts and alternatives 29

30 Defaqto Diamond Rating The Dynamic Focused family is relatively new; therefore, the performance and risk shape scores have been replaced by the scores from Defaqto s due diligence meetings with Prudential s investment team. In terms of the additional features, this family has an above average (relative to the peer group) number of funds in the family, large family AUM and a below average OCF due to its use of in-house or passive fund managers for most of the underlying funds. Overall, this family receives a Diamond Rating of 5. For each individual portfolio, the following pages show: its asset allocation, its Defaqto Risk Rating, the type of investor likely to invest in it (based on the Risk Rating) and its historical performance. 30

31 Dynamic Focused 0-30 Portfolio ISIN code: GB00BF232C79 Fund description The fund aims to provide income and capital growth, investing mainly in other funds which provide global exposure to a variety of asset classes including company shares, government and company debt securities, property and cash. No more than 30% of the fund will be invested in passively managed funds whose predominant asset type is company shares, with the remainder invested in actively managed funds that have an exposure to other asset classes. The fund will concentrate on delivering returns from the portfolio manager s asset allocation decisions and the selection of a focused range of funds and fund management groups (which may include other funds managed by the portfolio manager). Dynamic Focused 0-30 allocation (%) UK Equity 7.38% Eur ex-uk Equity 3.17% US Equity 2.95% Japan Equity 1.35% Asian Equity 3.19% EM Equity 0.93% Property 8.90% IG Corp Bond 55.21% HY Corp Bond 2.90% Conv Bond 1.67% Lev Loans 3.08% Cash 6.27% Alternative Assets 3.01% Source: Prudential, as at 31 December 2017 Investors at risk level 3 tend to target a modest level of growth via a portfolio of mixed assets. Their portfolios will primarily be invested in fixed interest assets but also defensive equity and property so as to achieve relatively stable long-term returns. In the short term, they typically expect some volatility. Performance analysis Source of performance data: Financial Express (FE). Please remember that past performance is not a reliable indicator of future performance. The figures are intended only to demonstrate performance history of the fund over the period shown. They take no account of product or advice charges. The application of charges may impact the overall performance. The value of your client s investment can go down as well as up and the amount your client gets back may be less than they put in. 31

32 Dynamic Focused Portfolio ISIN code: GB00BVYTZX71 Fund description The fund invests mainly in other funds which provide global exposure to a variety of asset classes including company shares, government and company debt securities, property and cash. Between 10% and 40% of the fund will be invested in passively managed funds whose predominant asset type is company shares, with the remainder invested in actively managed funds that have an exposure to other asset classes. The fund will concentrate on delivering returns from the portfolio manager s asset allocation decisions and the selection of a focused range of funds and fund management groups (which may include other funds managed by the portfolio manager). Dynamic Focused allocation (%) UK Equity 11.39% Eur ex-uk Equity 4.73% US Equity 4.44% Japan Equity 2.23% Asian Equity 4.48% EM Equity 1.82% Property 11.36% IG Corp Bond 41.37% HY Corp Bond 3.35% Conv Bond 1.28% Lev Loans 2.61% Cash 6.32% Alternative Assets 4.63% Source: Prudential, as at 31 December 2017 Investors at risk level 4 tend to target a moderate level of capital appreciation by investing in a multiasset portfolio. Their investments will be mainly in UK fixed interest securities, equities in particular UK equities and property. They typically expect a moderate amount of volatility. Performance analysis 32 Source of performance data: Financial Express (FE). Please remember that past performance is not a reliable indicator of future performance. The figures are intended only to demonstrate performance history of the fund over the period shown. They take no account of product or advice charges. The application of charges may impact the overall performance. The value of your client s investment can go down as well as up and the amount your client gets back may be less than they put in.

33 Dynamic Focused Portfolio ISIN code: GB00BF232H25 Fund description The fund invests mainly in other funds which provide global exposure to a variety of asset classes including company shares, government and company debt securities, property and cash. Between 20% and 55% of the fund will be invested in passively managed funds whose predominant asset type is company shares, with the remainder invested in actively managed funds that have an exposure to other asset classes. The fund will concentrate on delivering returns from the portfolio manager s asset allocation decisions and the selection of a focused range of funds and fund management groups (which may include other funds managed by the portfolio manager). Dynamic Focused allocation (%) UK Equity 15.76% Eur ex-uk Equity 6.45% US Equity 6.17% Japan Equity 3.04% Asian Equity 6.46% EM Equity 2.17% Property 13.32% IG Corp Bond 29.55% HY Corp Bond 3.19% Conv Bond 0.80% Lev Loans 1.77% Cash 5.68% Alternative Assets 5.65% Source: Prudential, as at 31 December 2017 Investors at risk level 5 tend to target longer-term capital growth. Their investments will be mainly in fixed interest, equities with a UK focus and also some alternative asset classes, mostly property. They typically expect some volatility in return for the possibility of higher long-term returns. Performance analysis Source of performance data: Financial Express (FE). Please remember that past performance is not a reliable indicator of future performance. The figures are intended only to demonstrate performance history of the fund over the period shown. They take no account of product or advice charges. The application of charges may impact the overall performance. The value of your client s investment can go down as well as up and the amount your client gets back may be less than they put in. 33

34 Dynamic Focused Portfolio ISIN code: GB00BVYV0275 Fund description The fund invests mainly in other funds which provide global exposure to a variety of asset classes including company shares, government and company debt securities, property and cash. Between 40% and 80% of the fund will be invested in passively managed funds whose predominant asset type is company shares, with the remainder invested in actively managed funds that have an exposure to other asset classes. The fund will concentrate on delivering returns from the portfolio manager s asset allocation decisions and the selection of a focused range of funds and fund management groups (which may include other funds managed by the portfolio manager). Dynamic Focused allocation (%) UK Equity 20.41% Eur ex-uk Equity 8.26% US Equity 7.93% Japan Equity 3.57% Asian Equity 8.08% EM Equity 2.78% Property 15.34% IG Corp Bond 17.93% HY Corp Bond 2.43% Conv Bond 0.52% Lev Loans 1.26% Cash 4.10% Alternative Assets 7.38% Source: Prudential, as at 31 December 2017 Investors at risk level 6 tend to target a return using a portfolio with a higher equity content and a wider geographical spread. Their investments will be predominantly in UK and overseas equities, with an exposure to fixed interest and property in order to provide growth orientated diversification. They typically accept some volatility in return for the possibility of higher long-term returns. Performance analysis 34 Source of performance data: Financial Express (FE). Please remember that past performance is not a reliable indicator of future performance. The figures are intended only to demonstrate performance history of the fund over the period shown. They take no account of product or advice charges. The application of charges may impact the overall performance. The value of your client s investment can go down as well as up and the amount your client gets back may be less than they put in.

35 Dynamic Focused Portfolio ISIN code: GB00BVYV0721 Fund description The fund invests mainly in other funds which provide global exposure to a variety of asset classes including company shares, government and company debt securities, property and cash. Between 60% and 100% of the fund will be invested in passively managed funds whose predominant asset type is company shares, with the remainder invested in actively managed funds that have an exposure to other asset classes. The fund will concentrate on delivering returns from the portfolio manager s asset allocation decisions and the selection of a focused range of funds and fund management groups (which may include other funds managed by the portfolio manager). Dynamic Focused allocation (%) UK Equity 25.17% Eur ex-uk Equity 10.18% US Equity 9.98% Japan Equity 4.59% Asian Equity 10.18% EM Equity 3.42% Property 17.22% IG Corp Bond 6.48% HY Corp Bond 1.29% Conv Bond 0.26% Lev Loans 0.59% Cash 1.44% Alternative Assets 9.21% Source: Prudential, as at 31 December 2017 Investors at risk level 7 tend to target long-term capital growth by adopting a higher risk level. Their investments will typically be in UK and overseas equities, but also some alternative asset classes, for the purpose of achieving long-term capital appreciation. Performance analysis Source of performance data: Financial Express (FE). Please remember that past performance is not a reliable indicator of future performance. The figures are intended only to demonstrate performance history of the fund over the period shown. They take no account of product or advice charges. The application of charges may impact the overall performance. The value of your client s investment can go down as well as up and the amount your client gets back may be less than they put in. 35

36 Prudential Dynamic Focused Portfolios fund family performance Prudential Dynamic Focused Portfolios Sep 15 Nov 15 Jan 16 Mar 16 May 16 Jul 16 Sep 16 Nov 16 Jan 17 Mar 17 May 17 Jul 17 Sep 17 Nov 17 Source: Morningstar reinvested price series for P share class (Acc) rebased with Sep 2015 = 100 As mentioned above, this fund family has not been in existence for that long (although the Dynamic Focused 0-30 Portfolio and the Dynamic Focused Portfolio have existed since February 2007). The chart shows performance since

37 Charges and investment method Open-ended investment company (OEIC) charges (P share class) and investment method are shown in Table 2. Table 2: OEIC charges and investment methods Portfolio AMC (%) OCF (%) Investment method Dynamic Focused Active Passive Dynamic Focused Active Passive Dynamic Focused Active Passive Dynamic Focused Active Passive Dynamic Focused Active Passive Dynamic Active Active Dynamic Active Active Dynamic Active Active Dynamic Active Active Dynamic Active Active Source: Prudential, 11 January

38 How can the funds be accessed? The Dynamic Portfolio funds can be invested in directly, plus the Dynamic and Dynamic Focused Portfolios are available as an investment option in the products shown in Table 3: Table 3: How funds can be accessed Prudential ISA Prudential Retirement Account Prudential Investment Plan Prudential International Investment Bond WoL Prudential International Investment Portfolio Flexible Retirement Plan Full SIPP Prudential Trustee Investment Plan Star Rating Dynamic 0-30 Dynamic Dynamic Dynamic Dynamic Dynamic Focused 0-30 Dynamic Focused Dynamic Focused Dynamic Focused Dynamic Focused Source: Prudential The Dynamic and Dynamic Focused funds are available on many wraps and platforms. From the numbers used for our 2017 Diamond Ratings, the Dynamic and Dynamic Focused Portfolios were available on 38 and 37 different platforms respectively ( number of distribution partners is no longer used as part of Defaqto s Diamond Ratings). The Dynamic and Dynamic Focused funds appear within Defaqto Engage, our investment planning software solution, to help advisers select products and funds that are suitable for their clients needs and evidence their due diligence for compliance purposes. Advisers can filter the universe and select funds on the basis of a range of criteria, including charges and various different performance measures. As mentioned earlier, if a client has completed an attitude to risk questionnaire then their adviser can also view and select funds with a Defaqto Risk Rating corresponding to the client s risk profile. You can see more at defaqto.com/advisers/engage 38

39 Conclusion Risk bound funds offer investors access to disciplined, well-resourced and process-driven solutions to manage and meet client expectations and attitude to investment risk. Risk bound solutions managed with discipline lend themselves to maintaining alignment with a client s tolerance for loss, both now and in the future. In most cases it is possible for the client to invest in the same family of funds throughout their investment lifecycle. However, there can be significant differences in structure, process and other features across the various risk bound fund families in the market, so due diligence is still very important such funds need to be monitored to ensure that they are meeting their aims and objectives on an ongoing basis, as with any other fund. Also, the choice of risk bound family will depend on the investment beliefs of the client and their adviser: Do they prefer the lower costs of passive management or the potential to achieve outperformance that active management offers? Do they value the greater opportunity set that unfettered management offers or the lower charges of fettered management? Are they prepared to include alternative asset classes in their portfolios, with their potential diversification benefits and greater returns but possibly also greater risks? Defaqto s Diamond Ratings can act as a framework for research into and selection of risk bound fund families. Our rating methodology shows where each family sits within the risk bound universe on the basis of our criteria as well as providing a good indication of those families that have broadly delivered on their objectives. In addition, Defaqto s quadrant analysis of the multi-asset fund universe across four different investment dimensions has been designed to help, guide and educate the adviser market audience in this potentially complex area. Prudential s Dynamic and Dynamic Focused ranges are two examples of risk bound fund families. Based on our review of these offerings, we believe their strengths include: A large and experienced investment/research team, together with a financially strong parent company behind it A proprietary investment process which has been in place for a long time Above average number of funds in each family, covering Risk Ratings 3 7 (on a scale of 1 to 10) in which the majority of investors will tend to sit in terms of their attitude to risk Reasonable risk shape scores in the case of the Dynamic range and competitive charges for the Dynamic Focused family 39

40 Appendix A: moving between risk bound funds within the same family (decreasing risk) Katie is 51 and has recently won 75,000 from her premium bonds. She goes to see her financial adviser who has assessed her attitude to risk, and ordinarily she is a Cautious investor (Risk Profile 3). As this is a windfall, any loss will not materially affect Katie s standard of living; however, she would like to use this towards her retirement, scheduled for when she reaches 60. For this investment, Katie and her adviser decide her agreed risk level Balanced Growth (Defaqto Risk Profile 6). Katie s adviser researches the market for suitable funds or portfolios based on their discussions and her agreed risk level to meet her objectives. Katie s adviser recommends Prudential s Dynamic Focused Fund, with a Defaqto Risk Rating of 6, to correspond to her Risk Profile 6. Recommending this risk rated fund ensures the investment will be managed by Prudential in line with the agreed risk level. Katie continues to meet her adviser annually to review her investment. After four years Katie is starting to think more about her retirement, so they decide to reduce her agreed risk level to 4 Cautious Balanced. As Katie s existing investment is held within Prudential s Dynamic Focused fund family and since she is familiar with its investment process and the risk rating concept, her investment can simply be moved within the family to Prudential s Dynamic Focused fund with a Defaqto Risk Rating of 4. 1 Defaqto Risk Rating R I S K R I S K R I S K R I S K R I S K Source: Defaqto 7 DEFAQTO M A P P I N G 6 DEFAQTO M A P P I N G 5 DEFAQTO M A P P I N G 4 DEFAQTO M A P P I N G 3 DEFAQTO M A P P I N G Dynamic Focused Portfolio Funds Dynamic Focused Dynamic Focused Dynamic Focused Dynamic Focused Dynamic Focused 0-30 Katie continues to review her investment annually with her adviser in the run up to her retirement Although the adviser would still need to check the suitability of the new fund as part of their due diligence, they haven t had to carry out a massive research project to find potential new funds for the client.

41 Appendix B: moving between risk bound funds within the same family (increasing risk) Brian is 42 and he plans to save long term for his children s school fees. He plans to invest 60,000 initially with a target of 100,000 after 10 years. Brian and his financial adviser have reviewed his attitude to risk and capacity for loss. To achieve his required return, they have decided on an agreed risk level of 5 Balanced (Defaqto Risk Profile 5). Brian s adviser researches the market for suitable funds or portfolios based on their discussions and agreed risk level to meet his objectives. Brian s adviser recommends Prudential s Dynamic 20-55, with a Defaqto Risk Rating of 5, to correspond to his Risk Profile 5. Recommending this risk rated fund ensures the investment will be managed by Prudential in line with the agreed risk level. Brian meets with his adviser annually to review how the investment is progressing towards his target. After five years, Brian decides he wants to increase his target to 105,000 as fees at his preferred school have risen slightly more than expected. Brian and his adviser agree to increase the risk slightly, so they decide to increase his agreed risk level to 7 Growth. As Brian s existing investment is held within Prudential s Dynamic fund family and since he is familiar with its investment process and the risk rating concept, his investment can simply be moved within the family to Prudential s Dynamic fund with a Defaqto Risk Rating of 7. 2 Defaqto Risk Rating R I S K R I S K R I S K R I S K R I S K Source: Defaqto 7 DEFAQTO M A P P I N G 6 DEFAQTO M A P P I N G 5 DEFAQTO M A P P I N G 4 DEFAQTO M A P P I N G 3 DEFAQTO M A P P I N G Dynamic Portfolio Funds Dynamic Dynamic Dynamic Dynamic Dynamic 0-30 Brian continues to review his investment annually to ensure the investment is on track to reach his required return. 2. Although the adviser would still need to check the suitability of the new fund as part of their due diligence, they haven t had to carry out a massive research project to find potential new funds for the client. 41

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43 About Defaqto Defaqto is an independent financial information business, helping financial institutions and consumers make better informed decisions. Our experts research, collect and continuously assess over 41,000 financial products. Our process is extremely robust and is driven by over 60 specialist analysts who have unparalleled knowledge of financial products, services and funds in the market. Our independent fund and product information helps banks, insurers and fund managers with designing and promoting their propositions. Defaqto Ratings Defaqto Star Ratings are the most trusted expert assessment of products in the market. Products can receive a Rating of 1 to 5, depending on the quality and comprehensiveness of the features it offers; a 1 Star Rating indicates a basic product, while a 5 Star Rating indicates one of the highest quality products in the market. Star Ratings provide consumers, advisers and brokers with an accurate benchmark so that they can see at a glance how products and policies in the market compare. A Diamond Rating reflects the performance of a managed fund or fund family. Funds or fund families can receive a Rating of 1 to 5 based on a detailed and well-structured scoring process, allowing advisers and other intermediaries and their clients to see instantly where they sit in the market in terms of fund performance and competitiveness in areas such as fees, scale, access and manager longevity. A 5 Diamond Rating indicates it is one of the best quality funds available in the market. Service Ratings provide advisers with a simple and unbiased assessment of provider service. Based on advisers perceptions of the service they receive, providers are rated Gold, Silver, Bronze. Risk Ratings use the projected volatility of a fund using asset allocation and historic volatility based on observed standard deviations to map a fund to a Defaqto Risk Profile. Risk Profile 10 indicates highest risk and Risk Profile 1 represents lowest risk. Income Risk Ratings are unique to the market, comparing fund objectives, asset allocations, income and capital volatilities, and maximum drawdown. The Ratings are mapped to four Income Risk Profiles based on the income required and the level of risk. They are: capital preservation, low income volatility, medium income volatility, high income volatility. 43

44 Defaqto Engage Manage your financial planning process, all in one place, from a trusted source of fund and product information. Licensing Engage provides you with a simple solution to help you efficiently and flexibly meet all your clients needs, following your preferred financial planning process. Our Ratings are available in Engage. Engage at a glance: Over 5,500 advisers use Engage Over 500 risk rated funds Accumulation, decumulation and research workflows ENGAGE Helping you manage your investment planning process, all in one place, from a trusted source of fund, product and platform information Built-in risk profiling Import and review clients existing holdings Flexibility to choose portfolio construction method Unique, three-way, dynamic research to select compatible funds, products and platforms For more information, or to arrange a demonstration, visit Panel support Our unique in-house knowledge, expertise and market leading data, through Engage, provide a one stop solution to support advisory businesses panel construction and maintenance requirements. We can help strengthen your client adviser proposition by creating a panel to meet your business requirements (no matter how niche). We can also help you manage regulatory risk through developing repeatable processes to maximise your control. Our approach saves time and reduces cost by enabling efficient distribution of your panel across your business via Engage giving advisers a solution they can use with clients quickly and easily. For more information visit 44