Minimum and maximum equity limits offer limited assistance when selecting a suitable fund for a particular risk tolerance so, in the first of a new monthly column, Gill Hutchison suggests a range of other factors to consider
The Investment Association (IA) Mixed Investment 20-60% Shares sector corresponds to the old Cautious Managed sector, which was renamed by the (then) Investment Management Association at the beginning of 2012. Rather like the current debate about the definition for the IA UK Equity Income sector, there was much consternation and discussion around this change, given the number of interested parties involved.
The change was partly inspired by the desire to harmonise the naming convention with the Association of British Insurers and to shift the focus away from the word "Cautious", which had been used injudiciously in some cases - with unfortunate results for some disappointed investors. It was argued that providing consumers with a broad indication of a fund's equity allocation gives them a better understanding of how their fund might be invested.
This is a laudable rationale but the minimum and maximum equity limits are so wide as to provide limited assistance to someone trying to select a suitable fund for a particular risk tolerance. The upshot is that this sector, much like the other ‘Mixed Investment' sectors, are analytical projects in their own right.
To illustrate the point, we can look at the risk and return outcomes of three basic portfolios, divided between a simple mix of the broad UK equity market index and the broad gilt market index - 20% equity/80% gilts, 40% equity/60% gilts and 60% equity/40% gilts. In performance terms, the returns of the three mixes are fairly similar over one, three and five years (to 22/04/16), with the equity-biased mix helped by the recent market recovery from the February low.
In risk terms, however, there are significant differences and, given the increased volatility in the equity market, these are particularly evident over one year. The respective maximum drawdowns of the three portfolios are -4.13%, -5.21% and -8.46% while the respective standard deviations are 5.02%, 6.31% and 9.17% (all data from Morningstar Direct, using index returns to 26/3/16, based upon monthly rebalancing of the mixes, with risk statistics based upon weekly returns).
In passing, it is worth noting that the risk and return streams for the sector average are inferior to all three of these mixes over these timescales - in part, because gilts have outperformed higher-yielding credit, where funds are more typically well-represented.
Nevertheless, this simple analysis reinforces the point that the sector permissions allow for an extremely wide range of outcomes and, in a sector of around 136 funds, picking meaningfully through them all is no small task. It also reminds us that referring to the IA sector average as a performance and risk yardstick is pretty pointless.
So is there a typical asset allocation? In short, no! Reviewing the aggregate asset allocation breakdowns (using Morningstar Direct data) shows that funds in the sector are positioned across the full breadth of this equity range, from 20% all the way to 60% in equities. That said, the majority feature in the middle ground, with 40% to 50% in equities. Incidentally, based upon these asset allocation splits, this also means the bulk of funds are effectively "balanced" managed portfolios, arguably straying from the original concept of "cautious".
While fixed income remains the most commonly used complement to an equity weighting, the elusive ‘Asset allocation other' category is well represented in this sector. Logically, the larger fixed income weightings are seen in funds with an overt income objective, although diversified income funds can feature a range of other assets such as property and structured products.
By fund size, the sector is dominated by the longer-established stalwarts of the old Cautious Managed sector, with Jupiter Merlin Income Portfolio the largest fund at more than £3.6bn, followed by Invesco Perpetual Distribution at around £3.2bn.
In common with other IA sectors, there is a high concentration of assets in the top few funds and there is also a raft of funds with assets of less that £100m. This is in part because of the large number of distributor-influenced funds and bespoke wealth manager funds that find themselves in this sector but, given their restricted audience, are naturally smaller in size.
Breaking down the sector
The Adviser Centre currently features six funds from the Mixed Investment 20-60% Shares sector. To provide greater guidance around the likely shape of these funds, we place each fund into one of five asset allocation-driven categories, as described below. The fact we needed five categories for six funds tells us all we need to know about the diversity of the sector and the challenges of grouping similar funds together.
* Bond Biased, Primarily Pan-European Bonds and Global Equities: We feature Artemis Monthly Distribution in this category. Launched relatively recently, in 2012, it has a clear income objective and typically features 60% in bonds and 40% in equities, with little deviation.
* Bond Biased, Primarily Pan-European Bonds and UK Equities: We feature Invesco Perpetual Distribution in this category. The fund features at least 60% in fixed income and, while there is flexibility around asset allocation, a gradualist approach is taken with equities - typically in the 20% to 37.5% range.
* Equity Biased, Primarily Pan-European Bonds and UK Equities: We feature Henderson Cautious Managed in this category. This fund retains the original features of a relatively steady asset allocation, with an active equity exposure that is complemented by a fixed income/cash allocation that is primarily designed as an equity risk offset. Experienced manager Chris Burvill has resisted the more recent pull towards ‘multi-asset', arguing that understanding the relationship between equities and bonds is his key advantage. This approach also has the benefit of ensuring the fund is easy-to-understand and cost effective.
* Flexible Mix, Primarily Global Bonds and Global Equities with a UK Bias: We feature Investec Cautious Managed in this category. The well-known contrarian manager, Alastair Mundy, has shifted the fund over the years from a straight-forward equity/bond offering to a more mixed and globally-oriented portfolio. The basic tenet of the fund holds true, however - Mundy begins with his analysis of where he can find value in equities and then considers how he can balance the risk of owning equities through holdings in complementary assets. (A Video Factsheet, including a quarterly performance update, is available on this fund at www.theadvisercentre.co.uk)
Flexible Mix, Primarily Global Bonds and Global Equities: We feature JPM Multi-Asset Income and M&G Episode Income in this category. For both funds, income generation is the primary objective but, otherwise, the investment approaches are very distinct from each other. Credit is typically well-represented in the JPM fund and, given its higher correlation to equities, the fixed income element is less of an equity risk offset, as it is in other aforementioned funds, and more of an income play. The M&G fund is managed using a strong valuation discipline in a highly objective fashion, which results in a differentiated outcome. (Video Factsheets, including quarterly performance updates, are available on these funds at www.theadvisercentre.co.uk)
Many other factors to consider
Categorising funds around broad asset allocation mixes is probably the most helpful starting point for assessing suitability but, of course, there are many other factors to consider, including:
* What is the priority - income generation or total return?
* Is there an attempt to dampen capital volatility? How is this executed or what instruments are used?
* Is the fund invested directly into securities or is it a fund-of-funds structure? How diversified? What are the costs?
* What does multi-asset mean in practice for an individual fund? Remember that most instruments, however exotic they are, have equity-like or bond-like characteristics and risks. Are you being rewarded for the additional costs of investing in more complex funds?
* Is the fund targeting a particular volatility range (in other words, is it a risk-profiled fund)? If so, how strictly is this applied? How does the manager handle variations in market volatility?
* For those funds using a very flexible approach to asset allocation, have they described their investment objectives clearly? These funds can be the most difficult to match to a client's risk profile as, by their nature, their risk and return characteristics vary through time.
In conclusion, there are no easy wins here - the IA Mixed Investment sectors are rich with variety and each fund needs to be considered upon its own merits. Most importantly, every fund manager should be able to articulate the expected customer journey, clearly and succinctly. If they cannot, you will have precious little to tell your clients in the more challenging times.
Gill Hutchison is head of investment research at City Financial. To access the firm's free-to-air fund research and consultancy service, visit www.theadvisercentre.co.uk
