Sector classifications are under question

So how can advisers be sure they are getting the right funds if there is no direct comparison with similar products? Should the IMA – or data providers such as Morningstar or FE – consider introducing a sector or sectors for risk-targeted funds?

Legal & General Investment Management’s Justin Onuekwusi, who manages the company’s range of five risk-targeted funds, says such a development is inevitable.

“It is probably a natural evolution of multi-asset,” he says. “You will start to see something emerge as more and more funds are risk profiled.”

But the manager warns that any such sector or sectors would have to take into account the controversial debate over what risk ratings actually mean.

Mr Onuekwusi explains: “You wouldn’t necessarily be comparing like with like. Some managers take a 10-year view, some a five-year view of volatility and returns, so comparing risk metrics may not be fair.”

Architas’s chief investment officer Caspar Rock says there is “clearly demand from advisers” for funds to be comparable, but adds that doing so with risk-targeted funds is “very difficult”.

Most funds rated by Distribution Technology (DT) and its peers target a certain volatility band, but there are a number of funds which have been given a rating based merely on a ‘snapshot’ of their positioning.

Any investment decision needs to take into account this distinction, and any sectors based on risk profiling may have to do so too.

In addition, several products rated by DT are single-strategy funds which have been risk-rated on a ‘snapshot’ basis due to demand from advisers, rather than a choice by the provider. This would also have to be excluded.

Data from FE Analytics shows that, if Distribution Technology’s risk profile ‘5’ were to be launched as a sector with only risk-targeted funds included, it would be led by Standard Life’s MyFolio Managed III fund with a three-year return of 25.6 per cent to March 4. Manager Bambos Hambi’s asset allocation in this period has also helped the multi-manager and passive versions of this product rank in the top-five performers.

Meanwhile, Apollo’s Multi-Asset Balanced fund brings up the rear with a 4.3 per cent return over the same period.

The IMA’s rule of thumb when launching sectors is that it will not open a new group until there are at least 10 funds to populate it. Six of DT’s 10 risk categories meet this criteria, covering risk profiles ‘3’ to ‘8’.

But Mr Rock warns that this way of splitting up risk-targeted funds would pose problems.

He explains: “The question is what is the inclusion criteria? In the IMA sectors at the moment you choose which sector your fund goes in and the IMA monitors it to make sure it continues to meet the criteria.

“One option is that the IMA comes up with its own volatility levels to make its own sectors. But what would be the cut off point?”

Mr Onuekwusi adds that such a split would have unwanted echoes of the old IMA Cautious, Balanced and Active Managed sectors, which were accused of giving investors false impressions of what to expect from the funds within those groups. He continues: “What does a risk level ‘3’ actually mean? These types of products tend to be aimed at advisers. I’m not sure those numbers apply to end investors – you really need an adviser to hold the client’s hand through that risk profiling process.”

Equally, however, Mr Rock says launching one large sector for all risk-targeted funds would be of little use because the products would not all be directly comparable.

One grouping for all risk-targeted funds would differentiate the products from others but crucially the funds would not all be aimed at the same risk level, and so would not be comparable – when the ability to compare similar products is usually the reason behind launching a sector.

In addition, referring again to DT’s publicly listed profiled funds, more than 160 are risk-targeted – this means if the IMA were to list them all in one sector it would be bigger than each of the current Mixed Investment sectors and fourth largest overall, behind the IMA UK All Companies, IMA Global and IMA Specialist sectors.

But demand is growing, and it is not inconceivable that such sectors could exist in the future if they can be made workable.

Nick Reeve is deputy news editor at Investment Adviser