Many managed funds are not adequately diversified claims HSBC

Many top selling IMA Cautious Managed and Balanced Managed funds do not adequately describe their true risk profiles and their names may be misleading to investors, HSBC Investments warns.

Dan Rudd, Head of External Distribution at HSBC Investments, says the Cautious and Balanced labels attached to many managed funds would imply these were highly diversified and therefore relatively low risk.

However, Rudd says this is not the case, and most funds carrying these labels tend to be concentrated into UK equities and corporate bonds.

Rudd says that while the IMA guidelines for funds in the Balanced Managed and Cautious Managed sectors provide the opportunity for a strong balance of asset classes and international regions, this latitude appears not to be reflected in the asset allocations of many constituent funds.

To qualify for inclusion in the IMA's Cautious Managed sector, funds can hold up to 60% of their assets in equities. The IMA's Balanced Managed sector allows up to 85% equity exposure within the portfolio. Rudd says rather than opting for a diversified balance of asset classes, many funds invest near the maximum permitted levels in equities. This risk is then further compounded by a concentration on the UK.

"Considering the dominance of equities and the UK focus, it is fair to say that many such funds could hardly be described as Cautious or Balanced - though many are happy to call themselves this," Rudd says.

Rudd argues that to be truly Cautious or Balanced, it is necessary for these funds to hold a much wider mix of assets than just equities and bonds, and to take a global approach to investment. A fund which diversified into property, hedge funds, private equity and commodities would by its very nature provide broader geographic exposure. Overall, this would provide a better balance between risk and return for the long-term investor.

Rudd adds: "For clients seeking a managed approach, intermediaries need to ask themselves whether it is appropriate to rely so heavily on equity markets, particularly when there is such a strong focus on the UK. The UK equity market accounts for around 10% of global equities according to MSCI, and there is little advantage in UK based investors being heavily exposed in their home market."

Meanwhile, with investors today being more sophisticated than in the past, there is increasing willingness to have adequate exposure to areas like hedge funds, commodities, private equity and currency.

Rudd adds: "Managed funds should have an advantage here as they can potentially offer representation in these asset classes within the context of a properly-diversified fund. However, these asset classes are generally overlooked and are at best woefully under represented. These modern investments can offer important benefits and opportunities, and as they generally have little correlation to equity markets, they should be useful additions to a diversified portfolio.

"Perhaps it is time for clearer labelling and naming conventions for funds. This would ensure that funds which are globally invested and multi-asset are recognised as such and that this distinction is clearly defined. This would enhance transparency for advisers and investors, allowing them to more easily identify where their money is being invested."