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Disparities in fund sectors criticised in study

An analysis of the two most popular Investment Association mixed asset sectors has revealed wide variation in asset allocation that could have implications for advice suitability.

Risk profiler Dynamic Planner researched the IA 20-60 per cent Shares and IA 40-85 per cent Shares sectors, assessing both asset mix, volatility and performance.

Cash holdings in the 20-60 per cent Shares sector can vary from 20 to 0 per cent. Similarly, UK and international bond ratings respectively maxed out at 40 per cent but fell as low as 0 per cent in some funds. Property and absolute return allocations were spread as high as 20 per cent but, again, did not feature at all in other funds.

The 40-85 per cent Shares sector showed similar dispersion. Within the equities chosen, allocations to North America showed a range of more than 20 per cent, while global high-yield bond positions held in some funds reached 30 per cent, compared with others with none.

Dynamic Planner concludes that “just using sector peer group performance and external research ratings to make portfolio selections does not deliver investment suitability in isolation”.

Just using peer group performance and external research ratings to make portfolio selections does not deliver investment suitability in isolation

In terms of volatility, the IA 40-85 per cent Shares sector has maximum standard deviation of 10 per cent per year, understandably higher than the maximum 8 per cent volatility for the IA 20-60 per cent sector due to higher equity exposure.

However, the range of deviation within the 20-60 per cent Shares sector is greater; DT says that this is “likely to be attributed to the greater uncertainty in bond markets as yields have risen”.

The range of returns is wide for both sectors but particularly so for the 20-60 per cent Shares class, with the top performer returning around 33 per cent over a rolling three-year period, compared with a loss of 5 per cent for the worst performer.

For the 40-85 per cent Shares sector, returns range from just under 10 per cent to more than 40 per cent.

DP warns against assuming a uniform risk profile for each sector, despite the fact they are limited in share exposure, given the significant variation in risk scores for funds in each of the sectors.

The advice given to an individual client will have to relate to the risk bucket that client falls into

Its report concludes: “As the range of available solutions and track record extends over time, we expect risk targeting to become the default choice to power the centralised investment processes of advisory firms, as they look to ensure ongoing investment suitability.”

Distribution Technology chief executive Ben Goss says: “In a nutshell [the sectors] are not a good way of understanding the risk and investment strategy of a fund. They contain a very wide range of asset allocations and risks, which could easily lead to unsuitable outcomes.”

FE regulatory consultant Mikkel Bates says: “In terms of suitability, different funds will fall into different risk buckets, therefore the advice given to an individual client will have to relate to the risk bucket that client falls into.

“The issue at hand is not so much how much variation there is between funds, but how much the funds can vary over time. It’s a question of if there is currently a fund in the 40-85 per cent equities space has a DP risk bucket of four, if DP comes back in two years’ time, is it still going to be a four, or is it a five or even a six? That’s the problem that advisers need to look out for.”


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