By Tanya Jefferies for Thisismoney.co.uk 09:13 13 Nov 2014, updated 13:39 13 Nov 2014
High risk: Watchdogs want investors to understand what they are getting into before putting money in a fund
Two out of every five funds sold in the UK are in the second-highest risk band due to their volatility, according to a study by investment website Rplan.
Higher volatility is thought to indicate greater uncertainty about investment performance, and all funds are required by European watchdogs to use the same measure - the 'Synthetic Risk and Reward Indicator' - to make it easier for investors to understand their risks.
The SRRI ranks funds from band one for the lowest risk to band seven for the highest, but Rplan's research found that some 40 per cent, or 1,016, of the funds available in the UK fall into band six.
Meanwhile, a further 50 per cent or 1,275 of funds are split almost exactly between bands five and four. See the tables below for full results and volatility ranges for each band.
The value of the SRRI has been questioned because it looks back at fund returns over the past five years and uses this to gauge how dramatically they might fluctuate in future, so it provides no real guide to future performance.
Others argue that if such a large number of funds falls within a single band, this renders comparisons inside it meaningless using this measure.
But Nick Curry, director of Rplan, said the SRRI wasn't a bad measure because it standardised risk assessment across all funds, and was useful for finding out how risks vary across asset classes like cash, bonds and stocks and therefore in your portfolio as a whole.
However, he said that because the measure looked back five years, the financial crisis of 2008 has been skewing results as fund performance was much more volatile during that time.
Curry added that the SRRI was less useful when trying to work out the risk between different stock-focused sectors, and across regions like the UK, Japan and US.
This is Money did a snapshot check of the risk ratings of funds across different IMA investment categories, and found a well-known contrarian fund, M&G Recovery. a UK equity income fund, Unicorn Income. and a US fund, Old Mutual North American Equity. were all in band six.
In the targeted absolute return category, a type of fund designed never to lose money and often promoted to cautious investors, we found a fund in band five, City Financial Absolute Equity .
Curry said the results which surprised him were the CF 7IM Moderately Adventurous fund, which was in band four rather than six or seven, and the Aviva Investors Global Balanced Income fund which was in band seven rather than five or six.
How easy is it to
track down risk ratings?
Funds must state what risk band they are in on their Key Investor Information Documents (KIID), which were made compulsory by the EU in summer 2013 to help people understand investment products and their risks.
They are just a couple of pages long, come in a standard format, and can be a useful starting point for researching and comparing funds.
To find these documents, put a fund name and 'KIID' together in an internet search engine. Read more here.
Source: M&G Recovery fund
However, Rplan has carried out further research which shows that 44 per cent of personal investors find the way fund providers describe risk levels as either very unclear (9 per cent) or not very clear (35 per cent). A further 12 per cent thought firms were very clear.
In light of these findings, the investment website has called on the fund management industry to make risk ratings more obvious in their literature.
Curry said: 'There needs to be much greater clarity as to what level of risk and volatility funds have and although all funds have to provide their SRRI volatility rating, this needs to be more prominent in investor communication documents. The industry should be much more transparent about this.'
Risk assessment: Higher volatility is thought to indicate greater uncertainty about investment performance
HOW TO RESEARCH THE RISK OF A FUND
This is Money's guide to researching investment funds includes a look at the 'risk and reward profile' that appears on all KIID documents and is based on the SRRI.
The purpose of this part is to find out if a fund falls within your risk tolerance on a scale of one to seven, explained financial expert Gavin Haynes of Whitechurch Securities.
But he warned: 'Most funds that invest in the stock market are going to be listed as a six or seven.
'If you are assessing one stock market fund against another it provides very little guidance as to the relative risk.
'Obviously there is a huge range of funds investing in the stock market. You have to look at the specific risk and dig a bit deeper.'
Haynes said that most funds would be classed as above-average risk - four or above - with even a corporate bond fund probably at four.
Also, a cash fund might be one out of seven on the scale, but if you are investing long term that doesn't take account of the risk that money held in cash will be eroded by inflation.
Another thing to consider is that funds get assigned a risk level between one and seven according to how volatile they have been historically.
Haynes says: 'Risk is very difficult to measure. The thing to remember is these are based on volatility and they always look at what has happened in the past.