Page 101 - Profile's Unit Trusts & Collective Investments - March 2026

Investment risk Chapter 6

appropriate to the client’s risk profile and financial needs.
(see Sections 7 and 8 of the GCOC). Risk assessment Risk and basic investment
must be considered before advice is given. principles
In discussing risk with a client, an intermediary must There are a few basic investment
explore three distinct risk elements: risk required, risk principles that are worth repeating in
capacity, and risk tolerance (sometimes called risk every article or book on investing. They include the
appetite). following:
R Risk required: the level of risk that needs to be „ Start investing as young as possible – when it
shouldered in order to achieve a set financial comes to investment, risk generally diminishes
objective over a defined period (eg, the necessary over time.
rate-of-return) – this assumes that higher returns
can only be achieved with higher risk. „ Pay off all debt before investing – settling debt
is a totally risk-free investment.
R Risk capacity: the degree to which an investor’s „ Make informed decisions – ignorance is
financial resources (both income and existing probably the greatest investment risk.
capital) will allow the investor to shrug off market
downturns and remain invested (eg, a client must
have sufficient assets, cash and income security not to be forced out of long term investments).
R Risk tolerance: both the investor’s willingness to be exposed to market volatility (the danger
of capital losses) and the investor’s “nerve” – the ability to go the distance without panicking
during downturns.
Clear definitions of the terms “risk” and “risk profiling” are not included in the GCOC, possibly
because these words mean different things in the investment, life insurance and short-term
insurance contexts.
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 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.
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.
Risk management by fund managers
In August 2025, the FSCA, using its powers in terms of the Financial Sector Regulation Act
published a conduct standard for managers of collective investment schemes. Conduct Standard 3
of 2025 sets out how managers need to manage the risk of a fund.

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