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The IA sectors the experts want reviewed

26 May 2017

With the IA mulling a new mid-cap sector, FE Trustnet asks which other sectors the experts want to see cleaned up

By Jonathan Jones,

Reporter, FE Trustnet

Investment Association (IA) sectors could do with a review according to industry veterans, with the IA Targeted Absolute Return, IA Property and IA Mixed Investment sectors among the top sectors in need of improving.

Last week, FE Trustnet revealed that the IA are consulting with asset managers on the creation of a dedicated UK mid-cap sector.

Such a move could potentially see up to 14 funds leave the IA UK All Companies sector, as the IA embarks on some spring cleaning of the sector.

In a poll by FE Trustnet, advisers were asked which other sectors they would like the asset manager trade body to revisit.

Results of recent poll: Which IA sectors are most in need of cleaning up?

 

Source: FE Trustnet

Below FE Trustnet takes a closer look at the sectors that advisers and investors would like reviewed.

 

IA Targeted Absolute Return

In conversations with advisers and analysts the IA Targeted Absolute Return sector has been one of the most discussed. It was also the sector our readers wanted to see changed the most, leading the poll with 51 per cent of the votes.

A look through the sector shows that returns over the past five years are extremely varied, with the top performing fund – City Financial Absolute Equity – returning 140.94 per cent while the worst performer – Threadneedle Absolute Return Bond – has lost 6.63 per cent.

Performance of funds vs sector average over 5yrs

 

Source: FE Analytics

Adrian Lowcock, investment director at Architas, said: “You have a broad range of strategies, some are very appropriate for very different types of investors and you just can’t compare like-with-like in that sector.”


Bambos Hambi, who runs the Standard Life Investment Myfolio fund range, said he breaks the sector down before making fund comparisons.

He said: “In the absolute return sector you’ve got long/short funds, market neutral funds and you’ve got a wide variety of others so it is not a sector that you should be using to identify funds based on past performance.

“We don’t look at long/short funds or market neutral funds we ignore them and we create our own sectors. We have an absolute return bond sector and a multi-asset absolute return sector.”

Lowcock agreed: “I think to split them into bonds and equity would be a good step because there is no point comparing those two because people use their asset allocations differently.”

However, the Architas investment director also proposed looking at funds strategies to get a better understanding of the sector and the funds within it.

He said: “I think you’ve got to look at strategy as well because you have got things like the [Standard Life Investments] GARS fund which is, generally speaking, trying to be a bit more cautious.

“To compare that to things like the Crispin Odey funds, which are much more adventurous and risky, so to have a risk approach is quite important there.”

 

IA Property

The second most popular sector in need of review among FE Trustnet readers was the IA Property, which accounted for 17 per cent of the votes cast.

Ben Willis, head of research at Whitechurch Securities, said: “Property is another sector that is meaningless. It needs to be broken down between listed real estate and direct property funds if you want to use it for comparative purposes.”

The sector, which consists of 48 funds, includes a combination of bricks and mortar funds such as Henderson UK Property PAIF as well as real estate equity funds such as First State Global Property Securities though both act very differently, as the below graph shows.

Performance of funds vs sector average over 5yrs

 

Source: FE Analytics

Standard Life’s Hambi again uses his own quant screen to filter between the two types of fund before making an investment decision.

“We create our own sectors and clean it up. I’ve got a big team and we’ve got very serious systems in place where we can do all of that so we have to create our own peer groups and universes,” he explained.


 

IA Mixed Investment sectors

In third place were the IA Mixed Investment sectors which attracted 16 per cent of the vote. For this survey Mixed Investment sectors included: Mixed Investment 0-35% Shares, Mixed Investment 20-60% Shares, Mixed Investment 40-85% Shares and the Flexible Investment sectors. 

The four sectors are home to £126bn in assets and 564 funds, according to the latest data from the IA.

Mike Deverell, partner and investment manager at Equilibrium said this is the sector range he would most like to see the trade body act upon.

“Whilst the names implies the constraints are only around equity weighting there are more rules that many investors don’t realise,” Deverell (pictured) said.

“For example, to fit in the Mixed Investment 20%-60% Shares sector I believe a fund must have at least 35 per cent exposure to cash or bonds.

“This means the manager can’t hold property or alternatives in the ‘non-equity’ part of a fund. This is very limiting and reduces diversification. I would like to see these constraints removed.”

Meanwhile, AJ Bell head of fund selection Ryan Hughes said the sector parameters are too wide, with funds allocating 60 per cent to equities not comparable to those with 20 per cent exposure.

“If you think about the 20%-60% equity that is a big range – even something at 20 per cent and something at 60 per cent – should you compare those? Probably not,” he said.

“I have had instances over the years where we have had to do additional explanation to clients because they’ve been doing sector rankings and we have suggested it hasn’t been fair.”

 

None

While 88 per cent of our readers believed one of the featured sectors should be reviewed, 12 per cent did not think these sectors were in desperate need of review, a view shared by some other industry professionals.

Andy Merricks, head of investments at Skerritts, said: “Regarding the IA Sectors, I’m ambivalent really. I’m happy to look inside a fund and buy it on what it holds rather than what someone else tells them to hold.”

Hargreaves Lansdown research director Mark Dampier went one step further, arguing that there are already too many sectors.

“I just think there’s too much already. I have sympathy with it, but the answer to all these things is to look under the bonnet,” he said.

“Look at small-cap funds for example and you will find people like Harry Nimmo there. Harry’s done a great job but he tends to go through to the mid-cap and even FTSE All Share– he held Hargreaves Lansdown shares for a long time through the mid-cap. So if you wanted really pure small-cap you wouldn’t buy him.

“But where would you put that fund? Do you sub-divide small-caps? It just endlessly goes on and I just think it confuses people even more.”


IA Sterling Strategic Bond

The area with the least backing for review from our readers was the IA Sterling Strategic Bond sector attracting just 4 per cent of the vote, but AJ Bell’s Hughes (pictured) believes this is another sector worth looking at.

“There are not that many funds that are genuinely moving the dial in strategic bonds,” he argued.

“You’ve got some funds that are permanently weighted to high quality government bonds, you’ve got funds that are tilted to high yield bonds and you have a few funds in the middle that are genuinely strategic.”

For example, currently the Allianz Strategic Bond fund has a 75.3 per cent weighting to government bonds while Legg Mason IF Brandywine Global Income Optimiser has 64.87 per cent in corporate bonds.

“Our job is to look through the mess, not look at quartile rankings and try to determine what the right strategy for now is,” Hughes said.

“You need to do a look-through in terms of have they got the ability to use flexibility and have they used this.

“While you may be comparing apples with apples you’re comparing a granny smiths with a gala which looks like an apple, is an apple but tastes very different. I think that is the problem that we have.”

 

IA Unclassified/Specialist

Not on the poll, but sectors that have constantly come up in conversation with some of the industry veterans, are the IA Unclassified and Specialist sectors.

AJ Bell’s Hughes said: “Back in the day there weren’t as many funds in the unclassified sector because they had a natural home but investing has changed and I think you can see that the nature of IA sectors haven’t kept up with the way that people invest. I guess it tells you there is a problem.”

Whitechurch Securities Willis added: “There are a couple of sectors that appear to be for funds that just do not adhere to other sector definitions. These contain such a varied mix of funds, that it is worthless using either of these sectors as a benchmark.”

This sector is home to a number of different funds with the majority unable to move out due to the lack of a defined sector comparison.

Architas’ Lowcock said this shows that there is a need to add more sectors, but noted that he is against single-strategy funds being put into small sectors.

“I’m less concerned about single strategy-type funds like healthcare or something but more about alternatives as an asset class,” he said.

“This is growing in popularity so surely we need to think about how we address that but the problem is that alternatives are quite a diverse bunch so it does get very complicated very quickly.

“People looking to buy alternatives would be able to go to the alternatives sector and then make their choice.”

In an upcoming series FE Trustnet will look into each of these sectors individually and assess potential ways they may be cleaned up.

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