ima's move to break down the giant uk all companies sector into more simple sub-sectors has been welcomed by most of the industry
The UK All Companies sector has come under increasing scrutiny over the past few months as advisers and fund managers alike question the merits of the giant catch-all category.
The topic has been hitting the headlines once more as June beckons, the month when data provider Lipper will start to provide the IMA with portfolio breakdowns, enabling the trade body to start monitoring funds and their adherence to sector specifications.
Despite the extra ability to anatomise the sector into smaller groupings that this will bring, the IMA has confirmed there will be no changes to the sector until the end of the year at the earliest. The trade body is also aware that caution is necessary.
It has a wide and diverse membership, many of whom have their own agenda for the sector and are happy to open the topic for debate much earlier.
The UK All Companies sector represents 39% of funds under management in the country, making it by far the largest of the 20 fund classifications. Total assets as of 12 April comprise £72.59m out an industry total of £185.43m.
There is no doubt the sector is the lifeblood of the retail fund management industry, representing the core area every fund group feels it must be represented in, but is it really doing the job investors need it to? In short, how useful a tool is it for comparison of past performance or as a guideline to the type of funds it holds? The IMA readily accepts that the UK All Companies sector does not provide information any more specific than the fact its constituent funds should be at least 80% invested in UK equities with a primary objective of attaining capital growth.
However, as easy as it sounds to break the sector down into constituent parts, splitting out trackers, ethical funds or focused funds, for instance, there are problems associated with such a move. Dorian Carrell, head of statistics at the IMA, said: 'One of the reasons the sector is so big is because UK funds are such a standard offering. There is an argument for splitting it up but, at the moment, it is honest and any changes we make have got to be consistent and not due to fads.'
A cursory glance through the 319 funds the sector contained at the end of March reveals the disparity in management styles and, indeed, investment universes used by the underlying funds.
Beside the more mainstream active managed growth, value, special situations, blue chip, focused and mid-cap funds, there also sit a range of index tracker funds and more niche ecology and ethical funds.
Brian Harvey, head of research at Lipper, said: 'There has definitely been a view in the industry that UK All Companies is far too big to be one sector. There are lots of different funds in there and you are not comparing like with like.'
The accuracy of some fund names with regards to describing the underlying philosophy or mandate of the vehicle is another issue. Although sometimes confusing, this is often a legacy of changes in ownership, fund manager or style drift over the years, not least because of the keenness of certain groups to maintain a fund brand strongly supported by intermediaries, whatever its relevance to the underlying portfolio itself.
Opinion is split on the most suitable differentiation by which the sector could be broken down.
Data provider Standard & Poor's already breaks the sector down into 12 sub-sectors along investment strategy lines for its own internal usage and its institutional clients. Michael McCormack, a spokesman at Standard & Poor's, said that this is the only way the group can manage the volume of information and provide any meaningful analysis of the numbers.
He said: 'From the fund of funds groups' point of view, the UK All Companies sector is a useful descriptor of what a fund does in general but beyond that it is just not useful.'
He said Standard & Poor's split out closed-end, ecology, equity, equity income and growth, ethical, fund of funds, special situations and recovery and index trackers, broken down into four types: FTSE 100, FTSE 250, FTSE 350 and FTSE All-Share funds.
Whether all observers agree on these differentiations is up for debate and the selection is largely down to Standard & Poor's own interpretation of the underlying funds' management styles and objectives, which can of course be changeable. The difference between an ethical fund and an ecology fund is put down to semantics by many.
While Jupiter and Scottish Widows may beg to differ, their Environmental Opportunities and Environmental Investor funds surely fit within the broadly unspecified notion of what constitutes an ethical fund and would surely not benefit from sitting in a two-strong sector. Carrell also raises the question of where this would leave an ethical tracker fund, like Close Fund Management's FTSE 4 Good fund.
McCormack added that Standard & Poor's is looking at further ways of breaking down its equity sub-sector, which still comprises 151 funds. One means may be the introduction of a further sub-sector for focus funds, given their increasing popularity.
US-owned Lipper is also in favour of breaking the UK All Companies sector down into smaller blocks but prefers to use a style differentiator.
Harvey said: 'Some people have requested a style breakdown into value or growth, or a combination of both. In the US, the investor public fully understands what style means ' the only thing is whether the UK public is ready for style classifications.'
Harvey noted the options are to class funds by market capitalisation of the underlying assets and possibly strip out passively managed tracker funds.
Tracker funds are currently flagged as being such in the IMA's data. Providers, including Virgin and Legal & General, are keen to keep their funds in the overall sector. When they are able to beat actively managed funds, it provides enticing marketing opportunities for them.
Carrell said the IMA will leave trackers flagged and not take them out in any case. He said some of its members are for this move and some against and to come down on either side would not be fair to a section of the membership. By flagging trackers, the option of stripping these funds out is left to the individual receiving the data.
Splitting out funds on a style bias basis has its flaws, as with any other means of breaking the UK fund universe down. Good managers can often switch between styles to adapt to market conditions, or alternatively run money with a barbell style, incorporating elements of value and growth strategies.
Moreover, many fund managers resent being pigeon-holed into one style category, preferring to describe their styles as pragmatic rather than rigidly growth or value. Carrell said the IMA is unlikely to pursue this avenue anyway as it would cause more problems than it solves, not least because it would have to be applied to all geographic sectors to ensure consistency of approach. Anyone for an emerging market value small-cap fund?
Carrell said: 'The value and growth argument is a lot more complicated than the data providers make out. They have their own definitions and want to push their own definitions of style into the marketplace. As far as we are concerned, it is a useless marker.
'We feel that even if there is a standard industry definition of value and growth, most funds will be a blend of the two and if we split out value and growth, we will have to change our whole processes. For Japan and the US, for example, it would mean changing everything.'
The IMA is consequently far more likely to strip out funds on a market cap basis, as it already has with smaller company funds.
Carrell said: 'The more change you have, the more confusion you get. If there are lots of sectors, every fund will end up being in the top 10 because there are only 10 funds. We already have a smaller companies sector, so to differentiate by size of company is logical.'
A possible split into mid cap and blue chip has enough funds of each nature to be viable.
The tendency of many UK growth funds to overweight the mid-cap sector would not be a problem as the 80% minimum investment in that asset class could be introduced, as is standard for many other sectors. Few funds would overweight the sector to that extent, all but eradicating overlap.
Carrell added that funds moved into alternative sectors would be allowed to keep their track records and the only opportunity cost in moving to a smaller sector, such as UK Mid Caps, would be for the marketing of funds.
Top performer out of 300 sounds so much more racy than first out of 10 funds.
Indeed, division on market cap basis does look the most likely way forward for the IMA. Although it will still leave investors with very large UK sectors, this is surely inevitable given the popularity of UK-focused equity funds. No solution will please everyone.
trying to make sense of performance statistics
Poor fund performance would be more difficult to hide if the UK All Companies fund classification was broken down into smaller sub-sectors.
Research in Investment Week last month revealed huge intra-quartile diversity in returns from the UK All Companies sector.
The top performer in the UK All Companies sector over the three years to the end of January, Solus Special Situations, was up 145.87%, compared with the bottom performer in the top quartile, Liontrust First Growth, up 8.05%, giving a 137.82% range in the top quartile alone.
The stripping out of ethical and ecology and special situations and recovery funds in the chart to the left indicates such a move by the IMA could be worthwhile.
The vehicles can be compared with their peers more easily and performance can in turn be compared with UK All Companies funds to provide a further comparison.
Moreover, indifferent performance will not be so easily masked because the quartiles will be a lot tighter.
If ethical funds were to be stripped out of the UK All Companies sector, many investors would probably be surprised to learn that, on average, ethical funds have returned -2.85% over the three years to 5 April, bid to bid, compared with a UK All Companies average return of -4.6%. Similarly, special situations and recovery funds, which have admittedly come into their own in the past two years' market conditions, have, on average, outperformed by more than 25%.
Over the three years to 5 April, special situations and recovery funds have on average posted growth of 22.35%, compared with a UK All Companies average of -4.6%.
At present, a comparison of any one sub-classification of funds within a broader IMA sector is laborious.
As long as the sub-sectors selected are of a worthwhile size and can provide sufficient levels of homogeneity of asset class to make performance comparisons legitimate, the move should surely be encouraged.
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