Where now for the multi-asset sectors?

After months of wrangling and consultation, June saw the IMA bow to pressure from its members and postpone its reclassification of the sectors pending further review. What are the likely solutions to the problem? Cherry Reynard reports.

It is worth starting with a definition of the problem. The criticism of the sector classifications is that they do not set clear limits on risk. For example, the Cautious Managed sector can have a maximum of 60% equity exposure and minimum of 30% fixed interest and cash. This definition allows for a broad spectrum of risk – a fund might have 5% or 60% in equities, it might have 35% or 95% in fixed interest and cash.

Some of this is necessary - many managers try to add value through asset allocation and therefore need some flexibility – but critics argue the definitions are so broad as to render comparisons between funds obsolete.

Equally, without any clear definition of risk, the equity component is subject to wild variation in composition. Darius McDermott, managing director of Chelsea Financial Services, says: “If a cautious managed fund has up to 60% equities, those equities could be GlaxoSmithKline or they could be Japanese smaller companies. Many of the weaker funds during the credit crisis had high weightings in emerging market equities, for example. Genuinely cautious funds do not fall 20-30% over a 12 month period.”

In 2008, for example, 28% of funds in the Cautious Managed sector lost more than 20% and only three funds delivered a positive return. This is a long way from most investors’ definition of ‘cautious’. Equally, the difference in performance between funds within the sectors is significant. Over five years, there is 88.1% between the top and bottom funds in the Balanced sector, 66.4% in the active sector and 66.9% in the Cautious sector, according to Trustnet.

There is also the problem managers in the sector will often look to the asset allocation of their peer group in determining their own asset allocation. This means that they are more likely to run with the maximum equity allocation in case markets soar away and they are left looking weak relative to their competitors.

Finding a solution

This has led to calls for the IMA to redefine the sectors to ensure they better reflect the risk levels of the funds. Mike Webb, chief executive of Rathbones, says: “These are going to be the most important sectors post-RDR as outsourcing becomes more important and it is vital the industry gets it right. We need a solution that is good for investors and good for IFAs and I’m not sure we’re there yet.”

The ABI stole a march on the IMA by issuing a paper proposing the equity allocation be included in the name. The Cautious sector would be ‘Cautious (up to 60% equity) Managed’, for example. At the time, the IMA dismissed the proposals, saying that focusing on just one asset class was ‘unhelpful’. The IMA came up with its own proposals at the end of May.

This was the conclusion of a lengthy consultation with the fund buyers and sellers. The proposals suggested a ‘deliberately concise and neutral’ classification of A, B, C and D for funds. The ‘D’ sector would be new and would sit below Cautious Managed on the risk scale. The proposed changes would also give the IMA the right to remove any fund that does not comply with the spirit of the definition. The changes were due to be implemented on 1 July.

Richard Saunders, chief executive of the IMA, defended his position in the IMA blog by pointing out the organisation had considered and dismissed other options: “It quickly became clear that words like "defensive", "flexible", "aggressive", "dynamic" and so on would run into exactly the same problems as the existing names.

“Another [solution] would be to describe in neutral terms the asset allocation. But something like “mixed asset - maximum 60% equities, minimum 30% fixed income and cash, at least 50% £/€” would be not only too long but more to the point would simply have confused most investors.