Are SRRI risk classes informative about pension funds’ risk–return characteristics?

In 2010, the Committee of European Securities Regulation (CESR) published the guidance on how to calculate the synthetic risk and reward indicator (SRRI) for Undertakings for Collective Investment in Transferable Securities (UCITS) to improve disclosure and presentation of risk information in relation to all UCITS. The SRRI methodology defines seven risk classes based on predefined values of annualised standard deviations of UCITS. In this paper, I discuss some of the issues related to the adoption of SRRI as the methodology for informing pension fund investors on their risk exposure and expected risk–return relationship.
Using a sample of 518 UK pension funds with group agreements over the period of January 1990 – June 2021, and 1,908 UK domiciled mutual funds that use the UK as the region of sale I show that
(i) the SRRI risk classes are roughly consistent with a separation of funds into investment groups such as equity, allocation, fixed income, property and money market, or a separation of according to their market beta (the MSCI World index is used as the proxy for the market portfolio).

(ii) the SRRI risk classification does not help investors assess the risk–return characteristics of funds that are allocated to SRRI risk class 5 and above (which is approximately two thirds of the funds in the sample).

(iii) the introduction of SRRI risk classes may encourage undue risk taking. For example, moving one risk class may not seem much of a change in risk to investors, however, moving from an investment within the SRRI risk class 4 to risk class 5 is equivalent to switching from investing in fixed income to equity, which are traditionally seen as having very different risk profiles.

(iv) preliminary evidence suggests that (i) to (iii) above are common to mutual funds and pension funds.