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IA launches consultation on ETF sector classification

The Investment Association has launched a consultation on including exchange-traded funds in its IA sector classifications.

The IA sector system is meant to make it easier for investors to compare fund, including on performance and charges.

The consultation on including ETFs in sectors has invited industry figures to give their take on it potential advantages or disadvantages this could have.

In line with the IA’s current approach to other fund types, only UK domiciled ETFs, or EU UCITs with HMRC reporting fund status would be included. The consultation will close on 1 February 2019.

Each IA sector has “a clear definition”, which sets out the criteria that funds must fulfill.

IA sectors are mostly based on asset classes, such as equities and fixed income, and may also have a geographic focus, for example Japan or North America. A handful of sectors also focus on investment strategy – like targeted absolute return and volatility managed.

Commenting on the decision to launch the consultation, IA director of investment and capital markets Galina Dimitrova says: “We are continually monitoring the fund market to ensure that the IA sectors reflect the wide range of products the asset management industry has to offer savers.

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“The primary purpose of the IA sectors is to serve the needs of consumers and their advisers and the addition of ETFs must be done in their best interests.”

ETF industry figures have welcomed the trade body’s move, arguing it could lead to greater transparency.

According to the UCITS ETF platform HANetf co-chief executive Hector McNeill the move shows “a great deal of foresight”.

McNeill says: “The fact is most investors have a variety of both active and passive strategies in their portfolios, including ETFs, and by including them in comparison tables, it will enable investors to gain a better understanding of how their portfolios are performing.

“Improving transparency in this way can surely only be a good thing for end investors, and we hope the scope of ETFs included can also be widened over time. The next generation of ETFs, such as thematic, smart beta and eventually active products, will sit very well in this initiative.”

McNeill adds: “These new ETFs will be much more focused on after fee performance rather than just being judged on how low the fees are, so to have them alongside active funds makes a lot of sense.”

The reports of a consultation on the inclusion of ETFs in IA sectors prompted some to caution against what they see as potential drawbacks, however, warning against confusion for investors and advisers when comparing funds.

Chelsea Financial Services managing director Darius McDermott says: “My view is that if it is a standard ETF, for example one that invests in UK equities, then it would be fine to add to the UK All Companies sector.

“ETFs are gaining popularity and are being more widely used, so it would seem a sensible and useful outcome.

“My objection would be if it has leverage, for example, as this would not be a like for like comparison, do the IA will need to make sure that the ETFs go into the appropriate sectors. What this may result in is a number of less-standard ETFs going into the unclassified or specialist sectors, which are already over-populated.

“This wouldn’t actually help advisers or investors make sensible comparisons and choices, so the IA may need to consider more specialist ETFs in more detail.”

AJ Bell head of active portfolios Ryan Hughes notes that ETFs are “an investment structure, they are not a way of investing”, and is also concerned about unclear comparisons.

Hughes says: “If what you’re doing is saying let’s have one sector for all funds, then it should include ETFs, funds and investment trusts, and surely that’s what they are saying here. If the IA are doing this for the sake of adding a load of passive funds to sectors then that just adds more confusion for investors.

“The inclusion of passive funds will mean that where you have got lots of passive funds in a sector they will occupy the bottom of the second quartile and the top of the third quartile, and active funds will sit above and below that – and that feels like a move that will create confusion for investors.”

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