IMA Unclassified – the home of risk-rated funds

However, many mixed investment strategies, including the Standard Life Investments (SLI) MyFolio ranges, the F&C Lifestyle range and the Old Mutual Spectrum range, sit entirely in the IMA Unclassified sector.

One potential reason for this, given the growing use of risk ratings and risk-managed strategies, is that some funds don’t sit well in peer groups that have different levels of risk, albeit with a similar strategy.

Iain McLeod, multi-asset investment specialist at SLI, says: “It’s a challenge, really. Traditional funds will benchmark themselves against an index or a peer-group sector, therefore all the funds in that sector have a similar type objective. So it’s quite reasonable to compare one against another.

“But when you’re running risk-managed funds the objective of the fund is different.

“Rather than using the relative performance as a measure of success, it is whether the fund is delivering its risk outcomes, and is the performance commensurate with the risk that you’re taking?

“To then put those funds into another sector sends out the wrong message because it’s not what those funds are trying to do – they’re not trying to beat the sector.”

John Ventre, head of multi-manager at Old Mutual Global Investors (OMGI), says the Unclassified sector is by definition already a dumping ground for funds that don’t fit neatly into other sectors.

“It’s a place for things to live that don’t have a natural home,” he says.

“The reason a lot of these funds – and my own Spectrum range – are there is because conventional asset class bands or constraints don’t necessarily align well with a customer’s risk tolerance.

“In a purely theoretical sense, you could give me a limit of holding no more than 50 per cent equities, but if I were feeling adventurous I could build you a portfolio that was riskier than equities, and vice versa.

“A portfolio of 60 per cent in equities and 40 per cent in cash could theoretically be less risky than one 100 per cent invested in bonds.”

He argues that the point of a risk target, or in some cases a risk rating, is to provide the portfolio manager with a risk budget to spend on assets they believe will perform best within those parameters.

“So the traditional mixed investment sectors from the IMA, which have defined asset class bands and asset class rules, don’t necessarily fit with that philosophy or mindset very well.

“The rationale for putting them in the Unclassified sector is to try to avoid pigeon-holing our investments and instead focus on customer outcomes.”

With the emphasis on understanding and responding to clients’ risk tolerances set to remain on the agenda of the regulator, the number of funds with specific risk targets or risk ratings is likely to increase further, and the IMA Unclassified sector could become their main home.

But Ben Willis, investment manager and head of research at Whitechurch Securities, adds: “To be honest, if the process matches independently risk-profiled outcomes and independently risk-rated funds, then IMA sectors become irrelevant.”

But if this range of investment vehicles continues to grow, could there be cause for the IMA to review its existing sector definitions?

Mr McLeod notes: “All the sectors at the moment are input focused, and that is how you monitor them. All the sectors have quite defined inputs, so you have to meet that requirement to be in the sector. When you have funds that aren’t going to do that, you are looking more at an outcome focus – are the outcomes consistent with each other? So they might have to change the way some of these sectors look at how funds are included.”

But Mr Ventre adds: “The IMA Unclassified sector will, I think, continue to be a home for risk-rated funds until there are frankly so many of them that they can start putting them together into appropriate peer groups with each other.

“That is a process obviously, but it takes time for enough funds to be developed to be able to build meaningfully-sized peer groups. You don’t want a dozen funds in a peer group; you need more than that for it to be a reasonable indicator.”

Nyree Stewart is deputy features editor at Investment Adviser