CONSULTATION ON THE FUTURE EVOLUTION OF THE INVESTMENT ASSOCIATION SECTOR CLASSIFICATION SYSTEM HOW TO ACCOMMODATE OUTCOME‐FOCUSED FUND STRATEGIES? February 2015
CONSULTATION ON THE FUTURE EVOLUTION OF THE INVESTMENT ASSOCIATION SECTOR CLASSIFICATION SYSTEM: HOW TO ACCOMMODATE OUTCOME‐FOCUSED FUND STRATEGIES? Executive Summary Strong growth in the Investment Association Unclassified sector is primarily due to the number of
funds that offer risk (specifically volatility) targeted or other forms of outcome-focused solutions that
have chosen to be classified there.
This consultation asks whether firms and users would find it helpful if the Investment Association
sector scheme adapted to give these funds better visibility, and puts forward two central options:
1. To move these funds which rely on asset allocation strategies to a new sector which would sit
alongside the Mixed Investment sectors (where funds also vary their asset allocation but
within specified asset parameters).
2. To create a distinct new area within the sector classification system for outcome-focused
funds.
Both options raise broader and significant issues about the future shape of the sector classification
scheme if the shift towards more outcome-focused products proves to be a permanent and expanding
part of the fund landscape.
Other considerations include the evolution of the pensions market, where a number of drivers are
seeing a greater outcome focus. One area that may experience significant growth in the coming
years is the ‘at retirement’ market, with investment funds being more widely used alongside or
instead of annuities. This may see both a greater focus on traditional income funds where specific
assets are used to generate an income and some evolution towards funds that have very specific payout objectives.
In this context, we are mindful of the collaboration with the Association of British Insurers (ABI) that
took place in the context of the harmonisation of the IMA and ABI mixed asset sector names and
definitions in 2011. We would like to continue that collaboration and therefore welcome comments
about the questions raised in this consultation from all parts of the industry, including life and pension
funds.
A key priority is to focus on the needs of consumers and their advisers, in particular to make sure
there are no ambiguities regarding the nature of any sectors that might be established for these
outcome-focused funds. With this in mind, we also ask whether there is certain information that The
Investment Association could provide through a filtering tool that would help the user make more
informed judgements about funds within outcome-focused sectors.
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Background The role of the Investment Association sectors historically has been to allow consumers and their
advisers the ability to narrow down the large universe of funds into more manageable ‘buckets’. Users
may use these smaller groups to make like-for-like comparisons before conducting further due
diligence.
Historically, the sectors have been asset based so that assumptions can be made on the types of risk
and return characteristics that funds in sectors might offer an investor over time. Advisers have used
these sectors to compare performance information and other characteristics and create portfolios of
assets which are broadly diversified by asset type. Some funds (within the Mixed Investment sectors)
have offered a mixture of assets to create diversification within a single fund. These funds have
typically been offered as part of a product suite so that, based on different asset tolerances, there is
a progressive risk and reward outcome over time.
With more funds being launched that aim to offer ‘solutions’, these are not easily accommodated
under the current asset based sector framework and the number of unclassified funds has grown
rapidly. The question therefore arises as to what action to take, with regard both to the current
landscape and future trends. The Investment Association sector scheme develops sectors around an
existing population of funds, but aims to take account of the changing nature of the market for funds.
One critical consideration therefore is the extent to which this part of the funds landscape develops
further in coming years, and the shape that such development takes.
Evolution of the market in more detail
There is increasing evidence of a move away from a retail product environment in which investment
funds tend to be used as component building blocks in a wider strategy. Instead, outcome-focused
fund solutions are being offered as a one-stop shop for asset allocation or risk management. Funds
targeting volatility outcomes appear to be a large part of the product set that has been launched,
with others launching asset allocation funds with broader objectives to address retail investors’ focus
on the risk of capital loss rather than the volatility of returns.
There are 475 funds with a value of c.£80 billion in the Unclassified sector,1 of which there are
currently close to 200 funds with over £30 billion of assets that aim to produce an outcome – most of
them seek to match a client’s attitude to risk or other outcome through strategic asset allocation. To
put in this perspective, these funds represent 5.7% of the total number of UK authorised funds, but
just 3.3% of funds under management currently.
The nomenclature around these funds is currently unclear with risk targeted, multi asset, fund
solutions and asset allocation funds (AAFs) all arising as terms used by the industry and the broader
market. The outcome targets of these funds may be set out implicitly or explicitly in the funds’
objectives depending on a number of factors, including when the fund was launched and the
regulatory requirement at that time.
A small number of firms have elected to classify these types of fund in either the Specialist or Mixed
Investment sectors. In some ways, funds in the Mixed Investment sectors are similar in that they can
also vary their asset allocation. However, funds in the Mixed Investment sectors are constrained by
certain asset parameters and can be compared.
To date, most firms have chosen not to classify to the Investment Association mainstream sectors
since these funds’ primary aim is to deliver an outcome, often based on an investor’s attitude to risk.
Also firms may take the view that the nature of the fund is unsuitable for sectors where performance
comparisons are the norm. The reason for this is commonly that it may identify them relative to peers
in a way that does not provide like-for-like comparison given differing investment objectives,
1
More than half of the funds and the majority of assets in Unclassified can be found in private funds. Some Unclassified funds are only available for investment by institutional or internal clients. Page 2 of 8
particularly if such visibility suggests they are available in the wider retail funds market when this is
not always the case.
In summary, there has been a variation in approach from firm to firm which does not aid
comparisons.
The way forward The Investment Association has met a number of firms to discuss the growth in outcome-focused
fund solutions and has also discussed the issue with the Sectors Committee.
There have been three main proposals for dealing with these types of funds in the Investment
Association sectors which can be summarised as follows:

Option 1: Leave the funds in the Unclassified category as like-for-like comparisons are
inappropriate.

Option 2: Create a broadly defined additional sector under the Mixed Investment heading for
outcome-focused funds which currently may be recognised under the terms multi asset and
risk targeted.

Option 3: Create a large umbrella sector primarily to capture information on these funds as a
first step.
The Investment Association is also undertaking research with IFAs to establish their views, but
encourages all interested parties to respond to this consultation directly.
Implications of Option 1
Leaving funds in the Unclassified sector would recognise that comparisons of outcome-focused funds
may require additional due diligence by the user in order to understand the characteristics of
individual funds and whether they can be compared with others.
Implications of Option 2
Option 2 is an incremental approach to change the sector scheme. Funds that use an asset allocation
strategy to deliver a specified outcome would be put in a separate sector which would sit alongside
the Mixed Investment sectors. The distinction between this sector and the existing Flexible
investment sector would be that the funds’ stated objectives would be outcome-focused as opposed
to asset focused.
It could be that some of these funds may have additional/secondary outcome aims such as a bias
towards delivery of an income. It is not clear whether these would need to be broken out into
additional new sectors and where these would sit within the overall schematic.
Implications of Option 3
Option 3 is the most radical approach and would entail a major reorganisation of the sector
classification system. It would require us to break down the sector framework into sectors that are a)
asset based; or b) outcome-focused. The latter would include sectors such as Targeted Absolute
Return (TAR) and Protected and possibly funds targeting income.
As part of this process, we would also create a broad definition to capture all types of outcomefocused funds (excluding those already defined such as TAR and Protected), and provide a tool to
allow users to filter funds on select criteria that they believe may be pertinent to narrowing the fund
population. This tool would be similar to that developed for the Targeted Absolute Return sector.
A schematic which offers some suggestions for redesigning the sector scheme based on options 2 and
3 can be found in the Appendices.
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The Investment Association’s view The Investment Association is concerned that Option 1 may not provide transparency to a growing
area of the funds universe or provide information to consumers and advisers who use the sectors.
While we understand that performance comparison may not be entirely like-for-like, we believe that
consumers could benefit from identification of families of funds, with possible development of tools to
help understand characteristics and behaviour.
We believe there is a case for both Options 2 and 3:

Option 2 recognises that there are similarities between outcome-focused strategies to deliver
a client solution and Mixed Investment approaches based on asset allocation strategies within
certain asset tolerances and it develops the existing framework to accommodate the changes.

Option 3 seeks to find a long term solution in the sector framework for outcome-focused
funds which continue to grow – gathering outcome-focused funds together under a broad
definition could be the first step. However, this Option is also predicated on the current move
towards ‘solution’ approaches being permanent and not a function of recent market cycles.
It is possible that elements of Option 2 could be combined with Option 3 so that a new Mixed
Investment sector could be created with a filtering tool and extra data to allow for the additional
filtering of funds in the new fund population – in much the same way as the current Targeted
Absolute Return tool operates.
Outcome‐focused sectors which use volatility bands There has been some interest in the development of outcome-focused sectors which use volatility
bands as the basis for classification (sometimes called “risk-based”).
A primary concern for us is that there is more than one definition of risk. Portfolio volatility is the
main risk factor set out in many risk targeted fund objectives, but many retail investors view the risk
of capital loss or ‘losing money’ as their main focus. Funds may also exhibit other risk factors in
addition to volatility of returns such as currency risk or liquidity risk.
For those funds that target volatility, there does not appear to be agreement on a common basis for
measurement.
Categorisation on the basis of risk requires a consistent measure to have been established and
adopted by all funds. Introduction of a risk measure would therefore require agreement on the best
proxy for risk/volatility. The Synthetic Risk and Reward Indicator (SRRI) set by EU regulators is a
start, but it is an absolute rather than a relative measure, there are issues over the timeframe for
comparison, and it may not provide enough differentiation across funds. Although the risk/volatility
based approach has some attractions, there is a question mark over how well consumers would
understand what was being measured and whether it is representative of the message that a firm
would want to communicate on its product.
It is possible that volatility data could be made available from a third party under a filtering
mechanism in Option 2 and Option 3 – but there would have to clarity around the methodology used
to produce the data.
The Investment Association has produced a paper on Risk Measures and Risk Objectives of UK
Authorised Collective Investment Schemes that members may wish to read in conjunction with this
consultation.
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Monitoring In asset-based sectors it is relatively straightforward to set criteria for inclusion in the sector, and
independent monitoring is used to gauge ongoing compliance. The exception is in the area of income
where a definition was introduced to try to distinguish income funds from other forms of investment
approach.
As part of the then Absolute Return sector review, we introduced in 2013 an approach comprising a
combination of transparency and consumer tools used to provide a means by which to assess relative
performance. Our website carries data as to whether funds are delivering a positive return, and a
filtering tool to compare funds whose strategies are often highly diverse.
In the event that Option 3 is the preferred way forward, The Investment Association is considering
extending the approach used in the TAR sector.
Consultation questions The Investment Association would like to consult its members and other interested parties on
whether the sector scheme should be adapted to better accommodate these types of funds which
require a broad descriptor.
Overall architecture
1. Which of the proposals (1-3) set out above do you feel offers the best solution for dealing
with outcome-focused funds such as multi asset/risk targeted in the Investment Association
sectors? Or, if you feel there is a better alternative solution, please provide details.
Option 2
2. Do you think that a separate sector, which would sit with the existing Mixed Investment
sectors, should be created to accommodate outcome-focused funds with an asset
allocation/risk targeted strategy? Could a sufficient distinction be made between these funds
and those that populate the Flexible sector?
3. Are there any other incremental changes under Option 2 that would be needed to capture
any other fund biases such as a focus on income?
Option 3
4. Overall architecture – should the titles be ‘asset-based’ and ‘outcome-focused’?
5. Are there intermediate headings for other levels of the schematic?
6. Are funds which have explicit risk targets set out in their objectives a subset of a broader
universe of funds targeting outcomes through the use of strategic asset allocation
techniques?
7. How would you currently name and define the funds captured by this universe?
8. Could there be further sub-categorisation of funds that would populate the new outcomefocused universe, for example, based on income objectives?
Classification and monitoring
9. Do you see there being a role for an Investment Association filtering tool in helping
consumers navigate a new outcome-focused area of the sector framework? If the Investment
Association created a filtering tool for a new sector, which criteria should be offered as filters?
10. Do you agree with The Investment Association view not to develop outcome-focused (‘riskbased’) sectors defined by volatility bands?
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Your own fund range
11. Please provide a list of funds that you would be willing to move to a new sector if one is
created. Please mention if there are specific traits in a potential new sector that would
encourage you to move your funds. [Note: these answers will be treated in strict confidence.]
Other comments
12. Are there any other comments that you would like to be considered?
Next steps Members should send their response to Nicola Kembey, Head of Sectors, at
[email protected] or Richard Mawson, Sector Classification & Monitoring
Officer, at [email protected] by Thursday 2 April 2015.
The Investment Association and the Sectors Committee will consider responses and the outcome of
the research conducted with IFAs before reaching a conclusion.
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Appendix A: Consultation Option 2
Unclassified
All Funds
Funds that choose not to be classified into specific Investment Association sectors, or which have been removed from them for non‐compliance.
Fund Principally Targeting:
Capital Protection
Income
Fixed Income
‐ Money Market
‐ Short Term
Money Market
‐ Protected
‐ UK Gilts
‐ UK Index
Linked Gilts
Equity
‐ UK Equity
Income
‐ Global Equity
Income
Specialist
Growth
Mixed UK Equity &
Bond Income
‐ £ Corporate
Bond
‐ £ Strategic
Bond
Equity
‐ UK All Cos
‐ UK Smaller Cos
‐ Japan
‐ Japanese Smaller Cos
‐ Asia Pacific incl. Japan Mixed Asset ‐ Mixed Investment
0‐35% Shares
‐ Mixed Investment
20‐60% Shares
‐ Mixed Investment
40‐85% Shares
‐ Flexible Investment
‐ Asia Pacific ex. Japan
‐ £ High Yield
‐ China/ Greater China
‐ Global Bonds
‐ North America
‐ North American Smaller
Cos
‐ Europe ex. UK
Q2. Do you think that a separate sector, which would sit with the existing Mixed Investment sectors, should be created to accommodate outcome focused funds with an asset allocation strategy?
‐ Europe incl. UK
‐ European Smaller Companies
‐ Global
Q3. Are there any other incremental changes under Option 2 that Page 7 of 8
would be needed to capture any other fund biases such as a focus on income?
‐ Global Emerging
Markets
Mixed Investment Specialist?
‐ Targeted Absolute
Return
‐ Personal Pensions
‐ Property ‐ Specialist
‐ Technology &
Telecommunications Appendix B: Consultation Option 3
Unclassified
All Funds
Q4
Outcome Focused
Asset Based
Capital Protection
Income
Fixed Income
‐ Money Market
‐ Short Term Money ‐ UK Gilts
‐ UK Index Linked Gilts
‐ £ Corporate Bond
‐ £ Strategic
‐ £ High Yield
‐ Global Bonds
‐ GEMB
Specialist
Growth
Equity
Mixed Asset
Mixed Asset
Equity
‐ UK Equity Income
‐ Global Equity Income
UK Equity & Bond Income
‐ Mixed Investment 0‐35% Shares
‐ Mixed Investment 20‐60% Shares
‐ Mixed Investment 40‐85% Shares
‐ Flexible Investment
‐ UK All Cos
‐ UK Smaller Cos
‐ Japan
‐ Japan Smaller Cos
‐ Asia Pacific inc Japan
‐ Asia Pacific ex Japan
‐ China/ Greater China
‐ North
America
‐North American Smaller Cos
Q5
Thematic/ Asset Based
‐ Property
‐ Technology
/Telecoms
Q6,7,8
Protected
Targeted Absolute
Return
Risk Targeted
Q4. Overall architecture – should the titles be ‘asset‐based’ and ‘outcome‐focused’?
Q5. Are there intermediate headings for other levels of the schematic? Page 8 of 8
Q6. Classification and monitoring ‐ Are funds which have explicit risk targets set out in their objectives a subset of a broader universe of funds targeting outcomes through the use of strategic asset allocation techniques? Q7. How would you currently name and define the funds captured by this universe? Q8. Could there be further sub‐categorisation of funds, that would populate the new outcome‐focused universe, for example, based on income objectives?