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IMA sector rebranding fails to address the real concerns about risk

Lothar Mentel - 06 June 2011

News that the Investment Management Association (IMA) is to rebrand three of its most popular investment sectors have been greeted with cynicism and incredulity by many in the industry. It has been hard to digest the news without thinking that, by focusing on changing their names rather than imposing any more concrete guidelines on the investments contained within, a valuable opportunity has been missed.

The IMA began its industry-wide review back in Autumn 2010, following an increased number of complaints from investors and financial advisers who believed that funds classified within the Cautious and Balanced sectors in particular were carrying more risk than the names suggested. So, from July, the IMA’s Active, Balanced and Cautious sectors will most likely be known as Managed A, Managed B and Managed C respectively, with a new lower-risk Managed D category also likely to be created shortly.

The IMA says “the new sector names have been chosen in order to highlight that the funds are in some  way “managed”, which indicates that the manager has a degree of discretion (in this case relating to a degree of freedom over asset allocation) that is not present in all sectors.” This seems a little strange since the managed nature of the funds was never really disputed. Rather it was the “degree of discretion” available to fund managers, enabling them to stray beyond the boundaries of what investors considered to be cautious or balanced portfolio management , that has been causing the greater concern for investors and advisers. 

IMA sector classifications are determined by asset allocation and equity exposure, so a fund in the Cautious Managed is permitted to have up to 60% invested in equities, whereas a fund in the Balanced Managed sector can hold as much as 85%. There’s little further restriction on the type of equities or equity-like instruments into which they can invest. This leads to inconsistency between competitor funds and confusion among investors and advisers alike.

Here’s an example. Choose two funds from within the Cautious Managed sector with the same level of equity exposure and they could both have vastly different risk/return profiles. So theoretically whilst one cautious managed fund might be made up of lower risk defensive equities from the UK and Europe, another could have its equity allocation invested in higher risk emerging market stocks. Over time the difference between the performance or underperformance of these two ‘cautious’ funds could be huge.

No wonder then that investors have grown mistrustful of the fairly loose interpretations of ‘cautious’ or ‘balanced’ that seem to change significantly from one fund to the next. But if the funds aren’t doing what investors expect them to, then perhaps it is the funds themselves that should be held more accountable, rather than changing the names of the sectors to something more opaque to the everyday investor.

A good starting point would have been to seek out the views of advisers and investors, finding out just what terminology such as cautious, balanced and active means to them. Once defined from an investor’s perspective this could have laid the groundwork for more effective policing of the risk being taken by funds within each sector, simply by monitoring the ongoing volatility of their daily fund prices, ensuring they keep themselves within more tightly controlled risk boundaries.

At Octopus, the ten investment profiles within Octopus Portfolio Manager each target a specific level of risk as defined by long term portfolio volatility. The profiles are then managed to perform in line with this volatility target, rather than chasing a return target or attempting to beat a sector benchmark. Investors always know that their portfolio is being managed towards this target, delivering the best expected returns for a level of volatility they feel comfortable with.

Rebranding exercises rarely get a positive reaction. Most consumers are smart enough to realise that simply changing the name of something, or giving it a shiny new wrapper, won’t by itself deliver any improvement to the product within. By changing the names of their sectors the IMA risks being accused of missing the point. It’s not the sector names that investors struggle to get to grips with, it’s the way that funds marketing themselves as low risk are allowed to take on far greater levels of risk than most investors would reasonably expect.

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