A vital key: the power of market sectors

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It turned out that this control over funds’ performance was exerted by the Investment Association (IA).

As Richard explained in Part 1, the IA is the trade body for the investment management industry. And, as part of its function of regulating funds, it has designated 33 different sectors of the market into which all funds are categorised.

Each of these 33 fund sectors has a clear definition, with the IA stipulating which investments can and can’t be included. If a fund is listed in a particular sector, it has to stick by these constraints.

This is only common sense. If you are placing your savings into a fund, you want to know which area of the investment world it’s going to be operating in.

Will it be investing into high-risk specialist businesses or lower-risk gilts? What percentage of the total fund would be invested into which arena? Geographically, will it be investing in the United Kingdom, Japan or any other region in the world?

This is essential information for you, and is a control on the flights of fancy that the fund manager may have from time to time. They sometimes need reminding that regardless of how much they might like it to be, “Grimsby, unlike Hong Kong, does not translate into Fragrant Harbour”!

For example, a fund listed in the Tech and Telecomms sector can’t start putting some of its money into bonds or property, because that’s not what it was set up to do.

The 33 sector definitions are mainly based on assets such as equities, fixed income and commodities. Others have a geographical basis – for example Europe, Japan or North America. Then there are a few other sectors that are focused on strategy, such as Targeted Absolute Return funds.

With this new-found knowledge about the different IA fund sectors, I now understood what was happening with the funds that moved together.

If a particular sector was performing well, then the various funds in that sector would all tend to perform well. Within that sector, it was a question of a rising tide floating all the boats.

However, it was also apparent to me that not all the funds within a sector floated to the same height. Clearly some managers were better at selecting performing shares for their funds than other managers in the same sector.

The light also dawned on me that the various sectors performed differently as economic and political circumstances changed.

Looking back, this all seems perfectly obvious and straightforward. And it may well be so to you. But it wasn’t to me at the time. It was quite a revelation as the build-up of my numbers gradually revealed these fascinating traits and patterns.

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