Page 118 - Profile's Unit Trusts & Collective Investments - September 2025

Chapter 6 Investment risk

In the investment sphere, one of the challenges with risk profiling is that clients and intermediaries
often have different departure points. For many investors, risk is seen simply as the danger of losing
money (a reduction in capital). For the investment industry, however, inflation is seen as a significant
risk in long term wealth-building – a reality that may not be sufficiently appreciated by many investors.
In short, there is not always alignment on the pervasive risk of insufficient capital growth. In this
context, the industry tends to assume that reductions in capital are temporary (a result of market
volatility that time in the market will fix), whereas many investors are as rattled by “paper” losses as
permanent “realised” financial losses.
Another problem with risk profiling is that both investors and intermediaries sometimes use the
term “risk profile” as a synonym for just one of the risk elements outlined above and fail to balance
the three elements appropriately. A client might assert he has a high “risk profile” (meaning risk
appetite) without considering risk capacity, for example, or an adviser might refer to an investor’s
“good risk profile” (meaning risk capacity) without taking into account risk tolerance.
Risk profile questionnaires (like the examples in the next section) have been one of the main
tools used by the industry. The value of these tools is a subject of debate, with critics arguing that
they result in product recommendations based purely on a client’s self-assessment – and possibly
influenced by the client’s mood on a particular day. Nevertheless, in the absence of alternatives, risk
profile questionnaires continue to play a role in the advice process.
Risk profile worksheets
The unit trust industry in SA has since its inception been at pains to point out the potential risks of
the financial markets, particularly equity investments. By law, the fine print on all unit trust marketing
material warns investors that markets can go up and down.
Investors, however, are typically attracted by the potential returns and pay too little attention to
these warnings. The level of risk that was being taken on is often only appreciated too late – when
markets fall or specific sectors fall out of favour.
The two risk profile questionnaires in this chapter evaluate risk capacity (the level of risk
your circumstances allow you to take on) and risk appetite (the level of risk you can handle
psychologically). The questionnaires try to match your scores to the specific volatilities of funds. As
stated earlier in this chapter (see “Risk profiles of funds” on page 103), sector-based fund choices
are not sufficiently refined, especially when it comes to sectors with a broad volatility range, like
general equities, flexible funds and property. Targeting a narrow volatility band rather than a sector
is not only more precise, it also reveals possibilities across sectors. An investor with a score of 60,
for example (volatility of 15), could identify potential funds from nearly three-quarters of the available
sectors.
Tying the risk profile score to volatility can help to narrow a selection of potential funds within
sectors. Bear in mind, though, that volatilities shift (see page 110). The method used here is relative,
not absolute. Scores from the questionnaires do not define the level of volatility you can take on in
any absolute sense, only where you fall on the current continuum of volatility numbers. And note
that scores obtained on tests such as these are significantly influenced by your mood and market
conditions – research shows that people’s responses vary surprisingly over time.
For all the above reasons, the risk questionnaires should be viewed as exercises for exploring risk
appetite and risk capacity, not as a method of making fund selections.
Please note that volatilities in the Unit Trusts Handbook are annualised (see page 111)
Step-by-step guide
R Step 1: Complete both questionnaires and add up the scores.
R Step 2: Decide which score to use (usually the lower of the two). If your scores are close
together (within 10 points of one another) you can use the average.
R Step 3: Divide the score by 4 to get your adjusted score. A score of 20 becomes 5.
Armed with your adjusted score you can explore funds and sectors in various ways. For example,
you can look at Figure 6.9 to see which sectors incorporate your score and explore those funds in

116 Profile’s Unit Trusts & Collective Investments September 2025