The problem is that too often, when looking at performance records, we find we are comparing apples and pears. The present system, dividing the near-2,000 unit trusts and other collective funds into different sectors, has failed to meet the aims of the modern investor.
Not only do we want to see how a fund has done but also how it compares with its competitors. Yet some sectors contain a multitude of funds. "[Each one] can be miles apart, with different aims, investment strategies and geographic splits," says Kim North of Pretty Financial, a London-based firm of independent financial advisers.
Take, for example, corporate bond funds. Very much the flavour of the moment, at present these are included in either the UK or International Fixed Interest sector. But they range from conventional bond funds that invest in top-grade company loan stocks and generally carry a yield under 7 per cent, to those with much higher yields that invest in much higher risk, so-called sub-investment grade bonds.
And, in the case of some of the international ones, to provide their high yields, they could be investing in emerging market loan stocks and gilts, which could prove to be extremely risky indeed.
Yet looking at the sectors, there has been no way to separate these high- risk funds from their more conventional and lower risk competitors.
Other anomalies abound. One of the current arguments is whether investors will get better long-term growth from actively managed or tracker funds, those that mirror the performance of a chosen stock market index.
While most trackers are UK based, some are international. If you want to look at how the latter are doing, you look in the "international growth sector" which is fair enough. But to see how the UK trackers are performing, you need to look at the "UK growth and income" sector, a sector that excludes all those growth funds that yield less than the FTSE All Share Index.
The Association of Unit Trust and Investment Funds (Autif), the parent body for unit trusts and open-ended investment companies (OEICS), has been reviewing the sector definitions for the past 18 months. "This has thrown light on the areas where we need to improve the information available. So from 1 May this year, there will be changes," says Anne McMeehan of Autif.
"We shall be making them more meaningful, sensible and large enough. While we can't have 150 different ones, we'll flag those funds which are in sub-groupings too small to warrant a separate sector."
Just as important, Autif is trying to convince regulators that fund managers should include details of which sector the fund appears in their annual and half yearly reports.
The basic differentiation in the new tables will be between growth and income funds, then UK and international. Some of the major changes will include "growth and income" funds being merged into the growth sector while the sector called "fund of funds", for those unit trusts that invest in other funds rather than directly into equities, will disappear altogether.
Also going will be the investment trust sector for unit trusts that invest in their near cousins. The various funds will be distributed to other sectors depending on their investment strategies. A new sector will appear for protected and guaranteed funds, those that promise that you will get back at least the full value of your initial investment after a set time.
This will go some way to resolving some of the current problems. But some conventional corporate bond fund managers such as John Kelly of B2, part of Barclays, are still worried. "Most investors will still underestimate the degree of risk involved with the higher yielding corporate bond funds," he warns.
"They used to have a narrow definition, investing in the top quality stocks and gilts. But it is hard to find a yield of more than 6.5 per cent today with these. Now some, those with their widely publicised higher yields, have taken on different characteristics."
He points out that by buying sub-grade investments to boost their yields, they risk investing in companies that may default on their loans. He refers to Moody's, a firm that calculates the risks for government and company loan stock, with the very best being graded AAA (triple A) or AA (double A).
Anything from BBB down is referred to as sub-investment grade. "With a fund that has B-graded stocks, there's a 95 per cent chance of a default and a 47 per cent chance that it will have two or three such defaults," he warns. "These funds should have the right sector labels so that investors can better understand the risks involved".
To back his warnings, Kim North highlights the case of a large, conventional fixed-interest fund in 1994, during the last UK recession. "It had 2 per cent of its portfolio in the loan stock of a company that defaulted," she says. "This knocked back its performance record for years."
Anne McMeehan says Autif is trying to resolve the problem: "We are working to shed light on the sustainability of the yield and vulnerability to capital with some portfolios. This is a complex business as there are different ways to work out the yields on different types of fixed interest stocks such as gilts, bonds, preference and convertible shares."
It may take some time for Autif to reach its conclusions. But the forthcoming changes in sector classification should help investors to better compare like with like.Reuse content