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.
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.
Nonetheless, performance differentials can and do throw up a number of points of note. Table 1 illustrates the best performers in each of the Morningstar categories over the five years to 1 January 2018. It shows that no one firm dominates proceedings.
Instead, five different providers top the six categories. This suggests it may prove wiser to mix and match Volatility Managed funds rather than rely on a single provider across all risk bands. The counterargument is that funds from the same range will typically sit more simply with one another across the risk spectrum.
Despite several firms sharing the top spots, one provider does dominate the sector as a whole. Standard Life Aberdeen has 25 funds included in the group, in the shape of the various iterations of its MyFolio range. Seven of these products are included in Table 1.
The MyFolio funds, run by Bambos Hambi, span three distinct categories. The Market funds invest in index trackers and other passives; the Managed portfolios hold a variety of funds run by Standard Life Investments (SLI); and the Multi-Manager range buys funds run by both SLI and external asset managers.
There are also income variants of the Multi-Manager and Managed offerings.
Leading lights
As the table shows, the Market range has performed best over the past five years, rising markets ensuring that low-cost passives have been able to trump active managers in almost every asset class.
Another tracker fund, Architas MA Passive Reserve, tops the Cautious category. As this latter name suggests, the vehicle takes a prudent approach to asset allocation in a bid to achieve its stated target of a low level of volatility.
As of the end of 2017, 38 per cent of the product’s assets are in UK gilt tracker funds, with other bonds accounting for a further 20 per cent. Property makes up 10 per cent, and the remaining 30 per cent is held in equities – split across the UK, US and Japan.
The pair of SLI funds topping the Adventurous and Moderately Adventurous categories understandably target more aggressive allocations. Market IV holds more than 75 per cent of its portfolio in equities, a figure that rises to in excess of 95 per cent for Market V.
As with their active peers, all three offerings display evidence of strategic asset-allocation: Architas does not hold European or emerging market equities, for example, while SLI’s funds have US equity weightings of less than 30 per cent – well below the 50 per cent weighting found in global equity indices.
The other table toppers – Santander Atlas 4 Portfolio, Cornelian Managed Growth and Allianz Riskmaster Growth Multi-Asset – all use active funds to produce their returns.
The trio take slightly different approaches to portfolio construction. The Santander fund is the most conventional, investing in a range of externally managed active and passive vehicles across traditional and alternative asset classes.
Cornelian adopts a similar approach, with the notable exception of its domestic equity exposure. Here, the firm invests directly in individual securities, though no stock accounts for more than 1 per cent of the portfolio.
Finally, the Allianz fund invests in a selection of the company’s own portfolios, and then broadens its exposure through buying UK and US government bonds directly, as well as equity and currency market futures.
These differing tactics illustrate there is no one right way to build a Volatility Managed fund. But prioritising risk awareness over returns can mean performance fails to keep up with that produced by simpler multi-asset products. This focus also means there is less of a dividing line between passive and active within this sector – both use strategic asset allocation to diversify portfolios.
The question of whether allocating across a range of passives can continue to work in future, were markets to become harder to navigate, is up for debate. So, too, is the idea that active funds will naturally mitigate market falls when they do arrive.
Outcome answers
What is true is that the rise of multi-asset offerings, and now risk-targeted products in particular, is predicated on helping investors achieve a certain type of return whatever the market conditions.
In recent times, these funds have had little difficulty in staying within their volatility limits, because overall levels of market volatility have hit record lows. Many advisers turn to these products for a sense of security, but a true sell-off would represent unknown waters for many in the sector.
Table 1 also shows that very few of the leading Volatility Managed funds have been around for 10 years or more. Just 12 products in the sector have been in existence for a decade or longer, with the majority of these run by Architas or Santander, and just 17 were in existence at the time of the collapse of Lehman Brothers in September 2008.
As a result, advisers considering these options should ask questions about the portfolios’ ability to withstand a prospective period of heightened volatility – and whether they can stay within their prescribed risk limits.
Volatility Managed funds: Five questions to ask
1. Can the funds be compared with one another?
In short, not easily. Funds in the sector target differing levels of volatility, making comparisons tough. Better to divide up the sector using external categories, as shown in Table 1.
2. Will there be any further classification changes?
The IA is scheduled to conduct a 12-month review of disclosures in April, but an overhaul looks unlikely in the near term.
3. How many funds now sit in the sector?
There were 104 funds as of January 2018, the most recent additions being a set of Schroder portfolios in late 2017.
4. Do these funds have equivalents in the regular Mixed Investment sectors?
Many Volatility Managed products’ return profiles will be similar to other multi-asset funds. The difference is that Volatility Managed offerings focus primarily on ensuring risk levels are kept within a predefined band.
5. How popular have the portfolios proven with investors?
Since its launch last April, the sector has outsold the Flexible Investment sector and two of the three Mixed Investment groupings.
