The vicar of drawdown

Too much lockdown TV is getting to David Coombs, our head of multi-asset investments. But he may have a point about the varied performance of risk-rated funds and models during the corona crisis.

David Coombs fund manager against a fence on a field

Now into the fifth week at home and I’m on series three of This Country, a BBC mockumentary of teenage life in a Cotswold village. Tracey and I live in a not-too-dissimilar village in North Wiltshire, literally 10 miles from the Mucklowes’ abode.

On Wednesday evening, we were out for a walk across the fields on the edge of the village when Tracey spotted a giant pig. I, at first, concurred. Yet on further inspection it turned out to be a relatively rare breed of white cow. Townies! With This Country’s third and final series finished, Tracey and I could probably fill the void left by the gormless Mucklowes until we get back to the big smoke.

We then bumped into (more than two metres away but counts as bumped into these days) our next-door neighbour. He also happens to be the vicar. After sharing our fauna faux pas with him and his wife, I felt like I was in an episode of that other great rural comedy, the Vicar of Dibley. I know, we’re watching waaaay too much television at the moment, but hear me out.

There is one classic scene where the vicar, Dawn French, is walking along a flat country lane near the village with her beau. She suddenly disappears into a puddle more than five-foot deep. Couldn’t this be a metaphor for our industry’s approach to risk rating right now? Over the last 10 years, much of our industry has been focused on managing money within narrow bands of volatility aligned to risk profiles which themselves align to attitude to risk questionnaires. All good, efficient stuff for shuttling clients into portfolios with the ‘right’ amount of risk. Now this is not necessarily a bad thing if it is a part of the process. The problem comes when it becomes the process.

Exacerbated by almost 12 years of quantitative easing that kept volatility muted and an almost uninterrupted bull market, this puddle in the road has gotten very deep indeed. For years, many funds and model portfolios have been basing their risk ratings on volatility that may have been artificially low. Historically speaking, volatility has never been so low for so long.

What could go wrong? Well, as we have seen recently, the vicar is underwater. Many asset classes that are illiquid and volatile at times of market stress demonstrate low levels of volatility during normal market conditions because of that same illiquidity. Think aircraft leasing: low volatility, low volatility, then COVID-19 and you suddenly see huge drawdowns. Similarly, look at the drawdown in credit markets and equity markets during March and try to tell the difference.

Halfway through April, we have noticed that our multi-asset portfolio funds have lower drawdowns than other funds/model portfolios with the same risk ratings. Our funds have had lower drawdowns than funds/models with lower risk ratings than ours. This is partly due to our decision to hold put contracts on the S&P 500. Because options aren’t an asset class, risk-rating agencies struggle to put them in a volatility basket.

Given the varied performance and drawdown of supposedly similarly risky funds and models, there could well be a shake-up of risk ratings in the aftermath of the corona crisis as they are reassessed given their actual behaviour. That would cause problems for advisers who have mapped their clients to these ratings. If this were to happen, I would argue that it should be the funds which have done poorly and offered higher volatility than historical data intimated that should be bumped up the risk scale. It would be perverse if funds that made better returns while keeping their volatility within expected bounds were reassessed at a lower risk level. At the heart of the issue, however, is that we probably shouldn’t use volatility as the principal measure of risk in future. Think about put contracts: if the equity market is flat or rises after you buy them they have almost negligible volatility. If, however, markets fall significantly they do start to become very volatile assets. The irony is they reduce overall portfolio volatility at the same time.

There is no easy answer to this, but I think it’s important for the industry to review its approach to risk rating and move to a broader definition of risk. This is no one’s fault as such but it is incumbent on agencies and fund/wealth managers to work together to come up with a more rounded approach to assessing risk.

Until then, remain suspicious of overly flat paths and stay away from puddles … oh, and giant pigs.

Important legal information

This area of the site is for professional advisers

Please read this page before proceeding, it explains certain legal and regulatory restrictions applicable to the distribution of this information. It is your responsibility to inform yourselves of and to observe all applicable laws and regulations of the relevant jurisdiction.

This section of the website is directed only at investment advisers and other financial intermediaries who are authorised and regulated by the Financial Conduct Authority (FCA).

The information provided in this site is directed at UK investment advisers only and must not be circulated to private clients or to the general public. It does not constitute an offer to sell, or solicit an offer to purchase any investments by anyone in any jurisdiction in which such offer or solicitation is not authorised or in which a member of the Rathbone Group is not authorised to do so.

I confirm that I am an investment intermediary authorised and regulated by the Financial Conduct Authority. I have read and understood the legal information and risk warnings below:

Important Information (Terms and Conditions)

The information contained on this site is believed to be accurate at the date of publication but no warranty of accuracy is given and the information is subject to change without notice. Any opinions or estimates included herein constitute a judgement as of the date of publication and are subject to change without notice. Furthermore, no responsibility is accepted for the accuracy of any information contained within sites provided by third parties that may have links to or from our pages.

Rathbone Investment Management Limited ("RIM") is authorised by the Prudential Regulation Authority and regulated by the Financial Conduct Authority and the Prudential Regulation Authority. Registered Office: Port of Liverpool Building, Pier Head, Liverpool L3 1NW. Registered in England No 01448919.

In accordance with regulations, all electronic communications and telephone calls between Rathbones and its clients are recorded and stored for a minimum period of six months.

The information provided in this site is directed at UK investors only. It does not constitute an offer to sell, or solicit an offer to purchase any investments by anyone in any jurisdiction in which such offer or solicitation is not authorised or in which a member of the Rathbone Group is not authorised to do so.

In particular, the information herein is not for distribution and does not constitute an offer to sell or the solicitation of any offer to buy any securities in France and the United States of America to or for the benefit of United States persons (being resident in the United States of America or partnerships or corporations organised under the laws of the United States of America or any state, territory or possession thereof).

In order to comply with money laundering and other regulations, additional documentation for identification purposes may be required.

Rathbones shall have no liability for any data transmission errors such as data loss, damage or alteration of any kind including, but not limited to, any direct, indirect or consequential damage arising out of the use of services provided or referred to in this website.

Past performance should not be seen as an indication of future performance.

The value of investments and the income from them can fall as well as rise and you may not get back the amount originally invested, particularly if your client does not continue with the investment over the longer term.

Changes in the rate of exchange between currencies may cause the value of an investment to go up or down.

Interest rate fluctuations are likely to affect the capital value of investments within bond funds. When long term interest rates rise the capital value of units is likely to fall and vice versa. The effect will be more apparent on funds that invest significantly in long dated securities. The value of capital and income will fluctuate as interest rates and credit ratings of the issuing companies change.

Tax levels and reliefs are those currently applicable and may change and the value of any tax advantage will depend on individual circumstances.

Investing in emerging markets or small companies may be potentially volatile, as these investments are high risk.

The design, text and images are owned, except as expressly stated by members of the Rathbone Group. They may not be copied, transmitted, displayed, performed, distributed, licensed, altered, framed, stored or otherwise used in whole or in part or in any manner without the written consent of Rathbones except to the extent permitted and under the procedures specified in the copyright Designs and Patents Act 1988, as amended and then only with notices of Rathbones' rights.

Rate this page:
Average: 4.6 (9 votes)

Subscribe to the In the KNOW blog email

Archive