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All change, please

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10 May 2019

David Prosser shares his thoughts on our recent sector review.

All change then for the investment company classifications. The AIC has announced that a third of its current sectors are to be renamed and that 13 new sectors will be added to the current list of 46, each one taking a small number of funds from their existing homes. All in all, it’s quite a shake-up.

But is this exercise simply a matter of housekeeping, or does it represent something more fundamental? Well, in the grand scheme of things, the way in which funds are classified is a secondary issue. Investors and their advisers often buy funds with little appreciation of the sector in which they sit – and they tend to focus more on absolute performance than relative returns.

Nevertheless, it would be a mistake to think sector groupings aren’t important. They do provide a yardstick for making a judgement on how well, or otherwise, a fund is doing. If you’re invested in a fund with exposure to Japanese smaller companies, comparisons with other funds that have similar exposures are obviously more helpful than, say, a cross-check against a fund stuffed with US corporate bonds.

This is one reason why the AIC’s reorganisation is important. By tightening its sector classifications so that each group contains a less diverse range of funds, investors and advisers should find it easier to make meaningful comparisons. That’s important both when choosing a fund in the first place and when reviewing its performance (though data comparisons alone have their limitations).

However, there’s something else interesting going on here too. The biggest driver of the AIC’s shake-up has been its recognition that the past five years or so has seen a big spike in the number of closed-ended funds that offer investors exposure to alternative assets.

In fact, the rise in alternative assets under management has been remarkable.  The sums invested by investment companies in alternative assets has jumped from £39.5bn to £75.9bn since 2019, a 92 per cent increase.

It’s not just scale that has increased; there has also been a striking broadening in the range of alternative assets available. Not only has the choice increased in conventional alternative asset classes such as debt and property, but we’ve also seen the emergence of completely new areas of investment. The AIC’s new Royalties sector, for funds that invest in royalties in the performing arts, may only have one constituent for the time being, but it’s a case in point.

In light of this trend, the AIC’s existing classifications had begun to look out of date: they haven’t kept pace with the fast-expanding choice of funds available to investors looking for less conventional asset allocation options.

In that context, this reclassification is also a reminder of how the unique attributes of investment companies mean they are so suited to investing in alternative assets, which are may be illiquid or prone to swings in sentiment.

The closed-ended structure of the fund leaves the manager free to get on with running the assets, rather than having to worry about inflows and outflows of investors’ cash. The problems experienced by open-ended property funds following Brexit, when several had to close temporarily to redemptions, illustrates the potential difficulties of holding illiquid assets in other types of vehicle.

All in all, then, the AIC’s new sector classifications are more than just a reorganisation. The exercise offers a snapshot of how the investment company industry as a whole is evolving and innovating – and, most importantly of all, it makes it more straightforward for investors and advisers to get to grips with the new opportunities emerging.

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