The Investment Association (IA) is looking at including exchange traded funds (ETFs) in its sector classifications, potentially changing the way investors find, compare and select funds.
The IA sectors are groupings of funds that invest in similar areas, such as UK equity income, which allow investors to compare one fund’s performance against another. It also allows comparison against the sector average, showing which funds can beat their peers.
Fund and sector comparison tools are widely available on private investor platforms. However the IA has only ever included open-ended funds and unit trusts in its sectors. Investors have never been able to easily compare an open-ended fund with an investment trust or an ETF.
As part of the consultation, the IA said around 200 ETFs could enter the 37 sectors – adding to the nearly 4,000 open-ended funds already available. However final decisions on how many to include and how to include them will not be taken until next year.
The benefit of the IA’s proposals has come under scrutiny. On the one hand, making cross-fund comparisons easier would be beneficial to investors who prefer using a broad range of fund structures. However, given the large number of funds already on offer, including a further 200 ETFs would only make decision-making more difficult.
IA sectors are also generally used to find actively managed funds that are outperforming peers, by comparing them with the sector average. Given ETFs tend to be passive products they tend to be compared and judged on how well they track a benchmark and on their cost. Including more benchmark-tracking funds could also affect sector averages, flattering some active fund managers’ outperformance.
Ryan Hughes, head of active portfolios at AJ Bell, said the argument to make it easier for investors to compare different structures only worked if investment trusts were included as well. Currently investment trusts are grouped in sectors organised by the Association of Investment Companies (AIC).
He said: “If what you’re doing is saying let’s have sectors for all funds, then it should include ETFs, [open-ended] funds and investment trusts, and surely that’s what the IA is saying here.
“If the IA is doing this for the sake of adding a load of passive funds to sectors then that just adds more confusion. 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.”
The IA said it would only include ETFs for sale in the UK and only ones that physically buy and sell stocks to replicate an index. This would exclude synthetic ETFs, which use derivatives to replicate an index’s performance.
