The Committee of European Securities Regulators' (CESR) proposal to compress the riskiness of an investment fund into a single number will cause investors to make inappropriate investment choices and suffer losses as a result, warns EM Applications.

The investment risk solutions provider is concerned that CESR has essentially misunderstood what really is the relevant risk measure for an investor through its proposal, as outlined in its Key Information Document (KID), which closes tomorrow (10 September 2009). Relying on just one number to indicate riskiness, EM Applications said, is an indication of CESR's misunderstanding as "a key lesson from the Credit Crunch was that over-reliance on a single risk number led many banks to take excessive risks".

The KID, designed to inform investors of the key characteristics of an Undertakings for Collective Investments in Transferable Securities (UCITS) fund, proposes that a "synthetic risk indicator" be employed to communicate the riskiness of an investment fund, with a scale from one to six showing whether it is low risk (one) or high risk (six). This number will be based on the previous three years' performance of the fund.

"An understanding of risk is fundamental to successful investing," said Peter Ainsworth, managing director of EM Applications. "However, it is only meaningful when measured against a defined objective or benchmark and, for a particular individual or institution, when account is taken of the whole investment portfolio. There is nothing wrong with measuring historical risk; it is a useful measure in the hands of investment professionals - fund managers or advisers. But it has the potential to be profoundly misleading if presented to the public as the 'Regulator Approved' measure."

He added that it is likely to lead to investors to overweight 'low risk' funds in their portfolios, "unaware that a portfolio of similar low risk funds is possibly the riskiest thing you can do when seeking to build a pension pot".

The KID will replace the current Simplified Prospectus, introduced in 2002, and aims to increase investor protection and convergence across Europe.

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