It then ranks the funds in each of these three sub-universes on the basis of:
- Capital batting average - how often the value of the fund has been at or above its initial value.
- Conditional Sharpe and Calmar ratio - these are two different measures of risk-adjusted performance.
- Delivered yield.
- Income volatility.
- Rolling conditional Sharpe and Calmar ratios - measures of how consistent the above risk-adjusted performance has been.
- Average rolling batting average and forward yield.
- Dividend payment delay, where those funds taking more than the regulatory limit (four months) to deliver dividends to the investor are penalised.
- Fund manager tenure - a feature of many successful offerings is longevity of people and resource.
- Ongoing charges.
- Size of fund - it is generally accepted that most funds are not particularly profitable or comfortably sustainable until they reach a certain size; while funds that are too large will find their size impacts on investor returns due to liquidity and market impact issues.
- Overall size of the underlying fund management group.
- Ucits compliance - a key plus for any fund today is having Ucits status as it gives investors some assurance that certain regulatory and investor protection requirements have been met.
- Domicile - funds registered within Britain will enable investors to access the Financial Services Compensation Scheme (FSCS) if necessary.
The fund receives a score for each of these criteria on the basis of how it compares to peers for that measure. These scores are weighted by how important Defaqto believes each of these criteria are and then added up to give an overall score, which translates into a Diamond Rating, with 5 Diamond indicating best in its class and 1 Diamond being the worst.
More solutions bring greater risks for investors
The changes announced in the 2014 Budget have sought to give more responsibility to the individual in terms of retirement provision.
As a result of this legislation, the fund industry is now offering more solutions for post-retirement as opposed to just pre-retirement and income funds are figuring highly in this new growth, with the income fund market in the UK now more than £1trn in AUM.
However, while these changes give greater freedom to investors, they also mean greater risks.
In particular there is a danger that people could spend too much too soon, or invest badly, leading to longevity risk, where the individual outlives the money set aside for their retirement.
Investors at or in retirement therefore need suitable advice.
Ratings enable the adviser and their client to select the best income fund on the basis of several attributes, including risk-adjusted performance, stability of the fund management team and charges.
Patrick Norwood is an investment consultant at Defaqto
