How Volatility Managed funds compare and contrast

How Volatility Managed funds compare and contrast

Money Management’s famous statistics pages, found in the back half of the magazine, contain performance information for all UK fund sectors, large and small. These groupings tend to have a numerical consistency: funds open and funds close, but overall quantities stay more or less the same. 

At the start of the current decade, however, one sector began growing almost exponentially. Ironically, this grouping is the least well-known to everyday investors and advisers. 

The sprawling size of the Investment Association (IA) Unclassified sector, as well as the diversity of funds contained within it, means it is typically not included in less comprehensive fund listings. 

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Surge in risk-targeted funds

The principal reason for Unclassified’s popularity – its ranks swelled from 350 products in late 2011 to 480 three years later – was the mushrooming number of risk-targeted funds. Providers said these portfolios were not suitable for the existing Mixed Investment sectors, because they targeted a particular level of risk rather than aiming for a specific return.

Traditional multi-asset funds simply sought to produce a return from a diversified portfolio. Then came the shift to outcome-oriented products. 

Risk-rated funds were first, created in response to advisers’ improved risk-profiling efforts. These funds are allocated a particular risk ‘number’ by an external tool based on their asset allocation at a given point in time. The problem is that this rating assumes those allocations remain relatively static – whereas the fund manager may be under no obligation to ensure they stick to holding, say, between 40 and 60 per cent in equities. A change in the manager’s holdings might mean a change in risk rating, which leaves clients in the wrong product.

Enter risk-targeted funds. Intermediaries establish a client’s appetite for loss, and determine how much risk a client is willing to take. As a result their suitability assessments may mean allocating to a particular risk-targeted fund, content in the knowledge that no excess levels of risk will be taken – or so the theory goes. 

Hence the launch of the Volatility Managed sector in April 2017. It is now home to 104 funds, most of which have swapped the Unclassified shadows in favour of the greater scrutiny of an official grouping.

This tally makes it the ninth largest of the 35 main sectors in the IA universe. However, with the 104 funds spread across just 16 providers, the sector is more akin to a series of product ranges, with each sub-fund aiming to provide returns within a given band of volatility. 

It is a structure that makes performance judgements difficult. Comparing returns for funds targeting a high level of volatility with those targeting a limited level makes little sense. 

Turning the tables

In the hope of providing clarity, Money Management has divided funds in the sector into relevant Morningstar categories that define how risk-averse a portfolio may be. 

Grouping products in this way makes direct comparisons more feasible – although there will still be occasions where a less risky portfolio is included in the same group as a more adventurous peer. 

Given the sector’s focus on outcomes, ensuring each fund is delivering the right level of volatility for clients remains the most important consideration for advisers.