What are the risks of the Unclassified sector?

Joanna Faith looks at the risks and benefits of investing in a sector without a mandate.

With more than 2,000 UK investment funds to choose from, the IMA sectors are a useful tool to help advisers compare vehicles with similar characteristics and decide the best solutions for their clients.

When Rathbones Unit Trust Management launched its multi-asset portfolios to retail investors this summer, however, the group decided to shun the traditional sectors and opted to make its funds unclassified instead.

The IMA recognises Unclassified funds and puts them in their own category, which is defined as: “Funds which do not want to be classified into other IMA sectors such as private funds or funds which have been removed from other IMA sectors due to non compliance.”

According to the IMA, funds in the Unclassified sector have surged in popularity. The sector alone enjoyed £1.5bn of inflows during the second quarter of the year, 51% of all net retail sales in the fund of funds sector.

How to compare

But for advisers who screen IMA sectors as a first port of call, Unclassified propositions pose a number of obstacles, notably how to compare them against their competitors. When it comes to comparing peer performance, this classification is arguably redundant, because the sector is such a mixture of vehicles.

However, David Coombs, manager of the Rathbones funds, believes being within in a prescribed IMA sector is not always the best solution. His funds could easily have fallen into the Cautious or Managed sector but, he says, this would have been too restricting as the concept behind the funds is they are unconstrained.

“The Cautious and Balanced sectors have too bigger weightings to equities, particularly Cautious where up to 60% is allowed,” he says. “It means quite aggressive funds in that sector would always do well in rising markets and we would always be top quartile or bottom quartile because we have lower equity content. It would give off all kinds of wrong numbers.”

Coombs’ concern is that being in one of these sectors would mean the team focused on allocating against their peers rather than thinking about their investment objective, what they are trying to achieve and managing risk and return.

“We want the funds to be managed for the objective of the investor not managed for a ranking in an industry sector,” he adds.

“The industry has become a bit obsessed with performance within the sectors. That’s not a criticism of the IMA but more funds are launching with objectives such as ours and they don’t fit naturally into sectors.”

The hunt for information

Darius McDermott, managing director of Chelsea Financial Services, is not so positive about Unclassified funds. He says locating information about them is a big problem.

“When looking at a fund, I always use tables in the back of industry magazines as a starting point but the Unclassified sector is not printed in any of them. How many people go out of their way to look for performance figures of these funds?

“You want them to be in an obvious environment. Having said that, if I wanted to buy a fund and it was in the Unclassified sector I wouldn’t let it stop me, but it’s a matter of how obvious it is for me to find that fund in the first place.”

McDermott says he would want to compare the Rathbones funds against other like minded vehicles.

“I know what I deem to be a good multi-asset fund and I know who I deem to be Rathbones’ competitors. They mostly sit in the Cautious or Balanced Managed sector depending how much flexibility the manager wants to go into equities.

“My worry would be even if the manager is outperforming his competition, I’m not going to know anything about it.”

Independent mandates

Meanwhile, Justine Fearns, investment research manager at AWD Chase de Vere, says a number of questions arise when you see the word unclassified and advisers need to look at the investment mandate closely.

“Many managers don’t want to be in specific sectors because they feel like they are doing something a little bit different which is fair enough.

“But if they’re doing something different, we know from investing in the Cautious Managed sector that you need to drill down and understand what they are doing, how different it is and why they think that approach is better than others,” she says.

“As with all funds in all the non-homogenous sectors, there needs to be extra drilling down. You should do it for any fund but even more so for those in the Unclassified sector as you have no basic guidelines in place.”

Shunned funds

Some advisers rule out funds in this sector altogether. Martin Bamford, managing director of Informed Choice, for example, excludes Unclassified funds from his research and recommendations, preferring UK domiciled and regulated mainstream investment funds, as these fit the firm’s investment philosophy and satisfy the investment objectives of their clients. 
By ruling out funds in the sector, Bamford says he is not exposing his clients to the unnecessary risks associated with niche or specialist funds. “Funds that end up in this sector tend to have individual mandates that are harder to relate to the types of funds investors tend to understand,” he says.

He adds that IMA sector average performances can be useful when comparing funds but in sectors such as Unclassified, there is no meaningful comparison to be made between the funds and this, he says, is “certainly another deterrent”.

Bamford says: “The fact the objectives of the funds in this sector or their underlying assets do not meet the definitions of other IMA sectors is not reason in itself to automatically exclude them, but it is more difficult to find justification to include them.”

However, Roger Edwards, director of Vision Independent Financial Planning, is happy to consider funds in the sector. In fact he has invested in both Rathbones multi-asset funds: the Strategic Growth portfolio and Total Return portfolio.

Edwards likes the fact the funds have no benchmark. He says it gives the manager better investment decision making capabilities compared to someone who will be judged against the benchmark and has to react to short-term events and pressures.

He admits there is an element of difficulty when it comes to comparing Unclassified vehicles but with the Rathbones funds you still get performance updates.

He says: “There is no graph against a benchmark but there are still discrete performance figures available so you can still compare like for like.”

Edwards believes the IMA sector edges have been blurred. “When you look at what’s being invested often a Cautious fund might have a big equity content. Just going by the benchmark the manager has chosen is not necessarily the best way to judge performance. You have to look at what a fund’s done and look at performance against the range you’re considering.”

Richard Hancock of Cumbria-based Financial Management Bureau also uses funds within the sector. He understands why advisers may be put off but thinks they could be missing out on opportunities.

He has used multi-asset funds within the Cautious and Balanced sectors but he says multi-asset doesn’t really fit into these sectors. “You’re never going to have 60% equities in the Rathbones funds for example.”

To overcome the problem of comparing funds in the sector, he uses online portal FundsLibrary.