In its aim to standardise the provision of data from fund groups to permit easier comparison by advisers and investors, ESMA has introduced the Key Investor Information Document (KIID). One of the key components of the KIID is the Synthetic Risk and Reward Indicator (SRRI for short) which is used in the process of identifying funds' risk and reward disclosure. In doing so, the SRRI is defined as a seven level scale based on historical volatility bands of funds that fund managers are obliged to provide to their clients. Given its definition, the SRRI's relationship to risk is obvious, but what is its return connection?

In order to answer this question, we have studied a sample of approximately one thousand mutual funds available to Swedish retail investors (non-professional investors), picked from the broadest fund categories identified by Morningstar (including most of the largest equity and rates categories). Using data over total return provided by Reuters, we used a 5 year rolling window in order to retrieve an aggregated return series of each fund and SRRI level (given that sufficient amount of historical data could be accessed, 5 years minimum). From the result of the study presented in the table below, it is possible to conclude that there seems to be no monotonic relationship between the SRRI level of funds and their realised return as the expected total return peaks at an SRRI level of 5 and then starts to decrease. In light of this result, it could be perceived as misleading to talk about the SRRI as a risk-reward indicator since a higher SRRI does not necessarily generate a larger expected return. 

With that said, it should be emphasised that the numbers presented here in no way constitute an investment recommendation, rather they should merely be viewed as an illustration. It could of course be argued that the quantity of interest to the investor is solely the expected return (whereas here we are looking at realised returns), and hence the evidence presented here may not necessarily constitute a violation of the intention of the concept. 

  

SRRI 25th percentile of total return [%] Expected total return [%] 75th percentile of total return [%] Standard deviation [%]
1 7.59 10.06

13.26

3.82
2 13.78  18.87 

23.05

3.94
3 15.28  23.74  30.23 6.60
4 14.29  31.03  45.72 12.94
5 6.83  48.86  80.16 23.62
6 2.79  45.88  73.95 28.10
7 -26.27  32.78  50.93 43.14

 

References

ESMA