Move to pin right labels on funds
If you bought into any high-flying technology funds in 1999, you probably learned the hard way how fund classification systems can be misleading.
Many funds that purported to invest in a spectrum of technologies were dangerously overweight in dotcoms. When the crash came, many collapsed in a manner that did not match what was presented in the fund prospectus.
The reason investors were caught off guard, according to Robin Thurston, a research director with fund-tracking firm Lipper, is some funds were improperly classified in ways that distorted their risk profile or misrepresented their sector allocations.
The dominant fund classification system used today is prone to tracking errors and can be poor at following changes in management style. For example, during the stock bull run, many funds simply strayed out of their categories as fund managers chased the best performing stocks in an effort to boost fund performance.
Lipper is now introducing a new technique of fund classification, one which it says is more accurate and will benefit both investors and fund managers.
Known as holdings-based analysis, the technique looks closely at what fund managers are actually buying. By tracking holdings on a regular basis, Mr Thurston says it can more accurately classify funds into categories and track changes in management style.
The end result, he says, is that investors know what they are getting. It can also measure cash positions to reveal if a fund is highly geared, although it cannot tell exactly how the leveraging is applied.
'The push for more disclosure is partly about this,' he says. 'There shouldn't be a conflict between what investors thought they were getting and what they got.'
He adds most fund managers approve of the methodology, saying it makes intuitive sense and enables more accurate performance comparisons within sectors.
Holdings-based analysis has been used in Lipper's fund classifications in the United States for the past five years, to generally good reviews. Even institutional investors have praised the holdings-based approach for its faithfulness in representing fund characteristics and performance, Mr Thurston says.
Lipper plans to implement the new technique in Germany, Britain and Switzerland this year. The roll-out is slated for Asian markets in the middle of next year.
The new system replaces returns-based analysis, first developed by Nobel Prize winner Professor William Sharpe, who used an approach which sought to classify on the basis of investment style. The technique requires little data, only fund returns and the returns of a limited number of benchmarks. However, it was criticised for its dependence on past performance data, an approach that does not lend itself well to tracking changes in fund allocation.
Holdings-based analysis is much more data dependant, requiring each fund to reveal their holdings as often as each month.
Lipper is now contacting fund houses throughout Asia to gain their co-operation in information disclosure.
