Making IA sectors more granular may at first sight appear against investors' best interests but, argues Juliet Schooling Latter, it should assist advisers and their clients in making investment choices
A rose by any name other would smell as sweet - to quote the Bard. That may be well and good for flowers and star-crossed lovers in Verona, but can the same be said for investments? Does it make a difference if a fund like Marlborough Multi Cap Income - to pick a random example - sits in a sector called UK All Companies, UK Equity Income or even UK Equity Mid Cap?
That fund, which stands out for its unusual smaller company income strategy, currently resides in Investment Association (IA) UK Equity Income - and, as far as I am aware, there are no plans to change that any time soon. But it is a pertinent illustration of just how tricky it can be to categorise funds. Should we use its multi-cap mandate, income focus or substantial overweight to small and medium-sized stocks to decide where it belongs?
Challenges like these would seem to suggest that making the Investment Association's fund sectors more granular - as per the recent proposal to create the IA UK Equity Mid Cap grouping - is against investors' best interests. In reality, I think it would greatly assist in making investment choices.
Over the past 10 or so years, I have observed a major shift occurring in the retail investing mindset. Whereas the ‘product' used to be the main focus, nowadays people think first about their financial goals and then look for the services and solutions to meet their needs.
The Retail Distribution Review may have brought associated issues such as transparency and fees to the fore but the cultural change in how people approach investing runs much deeper than this. Policies encouraging everyone to take more responsibility for their pension savings have brought the idea of timeframes, risk levels and diversification into the spotlight.
Increasingly, clients are no longer satisfied simply to see a good set of performance figures in isolation. They want information presented to them in a way that helps them understand if this particular fund will meet their targeted objectives.
If they are investing for income, they may want to see not just yield but the dividend growth track record and the consistency of payments, perhaps. Or, if they are chasing stronger capital growth potential through mid caps, it can be quite misleading to measure a fund's performance track record solely against the UK All Companies average, given medium-sized companies have consistently outperformed their larger counterparts over the long term.
More than just a label
To assess these factors effectively, we must do our best to compare apples with apples. This is where the sectors can serve a useful purpose beyond simple labelling.
The IA's decision to lower its yield requirement on the UK Equity Income sector earlier this year is a case in point. Burying high-quality funds such as Evenlode Income or Schroder Income among the 260-plus funds that comprise the UK All Companies grouping - as happened when the funds failed to meet the sector's former yield hurdle of 10% higher than the FTSE All-Share over three years - does investors no favours at all.
They may instead end up selecting the highest-yielding fund they can find in the UK Equity Income sector and then being severely disappointed down the track if the dividend does not grow or if capital losses become an issue.
Likewise, the launch of the IA Volatility Managed sector in April has made it far easier to compare risk-targeting funds that were previously languishing in the IA Unclassified sector. Again, this move reflects an increasing trend for outcome-focused investment solutions.
The introduction of an IA UK Equity Mid Cap sector could bring similar benefits and create a more competitive environment. It would become much easier to see at a glance how a mid-cap fund stacked up against its real peers -, not just in terms of total returns, but also on metrics such as volatility, alpha and active share that can be the true indicators of a quality investment.
Juliet Schooling Latter is research director at FundCalibre
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