Question regarding the risk levels and estimated rate of returns

[Roman]

I was playing around on the “Set your investment goal” page, and estimated that the tool assumed the following annual rate of returns for each risk level:

• 3.8% for risk level 1
• 4.3% for risk level 2
• 5.3% for risk level 3
• 6.2% for risk level 4
• 6.7% for risk level 5

May I ask what’s the reason behind those choices?

I can’t help to notice that here’s only one fund in the risk level 1 category, and that fund has an annualized rate of return of 1.53% since inception on 17/Apr/2009, far below the tools’ estimation for risk level 1.

Also, I don’t think it is appropriate to give an estimated investment scale of less than 5 years, it is against the industry-wide recommendations and best practices. £10,000 invested in a risk level 5 fund indeed have a chance to reach £10,670 in one year, but that chance is often worse than tossing a coin. For your reference, a British investor (i.e.: in GBP) invested in emerging market equities between 1970 and 2019 inclusive would have made a loss in 24 out of 49 years, and made a less than 6.7% gain in 3 other years, only in 22 out of 49 years would the investor made a gain greater than or equals to 6.7%.

[Roman]

I’m unsure if anyone from Dozens has read this. If you have, could you please raise these questions internally, and let me know when you have got the answers?

[robert]

Hi @Roman - we did indeed read this, but unfortunately it was the day I caught Covid, so I have not been in a fit state to reply to a rather complex question.

I am not personally sure how you calculated those rates, but I will take it that there is good logic.

In general terms, we review the range of ETFs and other investments we consider offering based on a number of criteria (to cover risk levels, interests, markets, and more) so as to offer a reasonable and manageable range. Within those choices, we then review suitability and performance criteria to select the funds to put on our shelf.

As you know, industry standard risk ratings (which are included in the KIDs) are 1-7, but this is rather granular, so we have chosen to reduce this to 1-5. The original risk levels are still available to investors before they commit their money.

I am not personally sure how easy it is to find suitable Risk Level 1 investment alternatives, but I will pass that on and I am sure this will develop over time.

On a separate note, I understand what you are saying about the investment calculator being able to show investment terms that are less than 5 years. I will raise this internally. At this stage, this is a handy reference tool that needs to be read in combination with the suitability assessment we ask all customers to complete, and the advice that investments are longer term (in fact 7 years+) and that capital is at risk.

As we develop the app, am sure that we can add further ‘intelligence’ to this calculator to make it more personalised. It might also suggest that shorter periods (that would only work for smaller differences in investment value to target in any case) may not be right for investment returns and maybe offer potential alternatives (some of which we hope to introduce shortly but don’t exist in the app today).

Thanks for your detailed analysis and reviews.