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Risk measures dismissed as ‘meaningless’

Risk measures dismissed as ‘meaningless’

Tim Stewart
— 1 minute read

The current approach to explaining risk to superannuation members is so flawed as to be completely useless, argues Innova Asset Management.

Measures of risk such as 'balanced' investment options and the industry-developed Standard Risk Measure are flawed proxies for risk, according to super consultant consultant Innova Asset Management.

Investors would be better off ignoring balanced super fund return tables, says Innova, given there is no clear indication of the risks the super fund takes to achieve them.

The main problem is there is often no indication of what constitutes a 'defensive asset', with some funds allocating a high proportion of their defensive assets to infrastructure and property (rather than bonds and cash).

In addition, equity exposure is the underlying driver of at least 90 per cent of most balance fund returns, said Innova.

"There is no industry-wide accepted way to define the underlying risk (which is often equity risk) driving portfolio return," said the consultant.

Innova also took aim at the Standard Risk Measure, which was developed by industry in order to estimate the likely number of negative annual returns over a 20-year period.

But it does not convey the magnitude of losses, said Innova.

"For example, one year of -12.7 per cent (as the average balanced fund posted in 2008-09) is far worse than two years of -1 per cent," said the consultant.

"Investors are also likely to be misled by the nature of odds. If a fund estimates the likelihood of annual negative returns as one in 20 years (5 per cent) and it occurs, most investors will mistakenly assume the next 19 years are plain sailing. In fact, the odds of a negative year remain 5 per cent every year, regardless of past performance."

 

Risk measures dismissed as ‘meaningless’
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