Frequently asked questions
These Frequently Asked Questions represent the undersftanding of the IMA on the issues covered as at the date of publication and are provided merely as a guide. They are not comprehensive and do not constitute legal or any other type of advice. They may be subject to change and further topics may be added in due course.
General
Q1. Why does IMA have sectors?
Q2. How are funds classified to IMA sectors?
Q3. How are the IMA sectors managed?
Q4. How are funds in IMA sectors monitored?
Q5. How are the sector definitions enforced?
Q6. How is consistency maintained for Sectors Committee decisions?
Q7. Is there a right of appeal in respect of sector decisions?
Monitoring
Q8. Are investment trusts treated as equity assets for monitoring purposes?
Q9. How are fund-of-funds asset exposures calculated?
Q11. How are ADRs/GDRs treated in the regional equity sectors?
Q12. How are dual listed stocks treated?
Q13. How are derivatives handled in the monitoring?
Q14. How is an assessment made of a bond's geographic exposure?
Q16. How much can a Europe ex UK fund hold in UK equities?
Regulatory
Q17. Does the Treating Customers Fairly ("TCF") initiative have any relevance to sectors?
General
Q1. Why does IMA have sectors?
IMA sectors offer a way of dividing up the authorised funds universe into groups of funds to permit like-for-like comparisons to be made between the funds. This includes performance comparisons. The sectors are intended to help consumers and their advisers navigate around the large universe of UK funds and offshore funds where these are admitted to IMA sectors. Funds within a sector may still offer considerable variety, whether of investment approach (for example active vs. passive) or of choice of underlying instruments (for example large cap vs. mid cap stocks).
The integrity of the IMA sector classification scheme is overseen by the Sectors Committee - see Q3 also). Fund monitoring by an independent third party (Morningstarf) and enforcement by IMA seeks to ensure that funds in the sectors comply with the definitions.
As part of its management of the sector scheme, IMA aims to minimise confusion which may arise from frequent changes to a peer group of funds.
Q2. How are funds classified to IMA sectors?
At the outset fund providers choose which sector their fund should be classified to and submit their request to IMA. Funds should meet the sector parameters set out in their chosen sector from the outset as a failure to do so will generate a breach notification from the point of entry. Once classified, funds should aim to stay in line with the sector definition on a continuous basis.
If the mandate of the fund and the criteria for an IMA sector diverge, the manager of the fund must still comply with the parameters set out in the IMA definition if it wishes to remain classified to that sector. It is a matter for the manager how he handles this.
IMA publishes forms on its website for fund classification, sector change requests and fund mergers.
Q3. How are the IMA sectors managed?
IMA staff deal with requests for sector classification, sector change requests and mergers. Also IMA handle the work for setting up new sectors and merging, changing or closing existing sectors.
The SC provides governance over and advice on the IMA sectors. It is made up of representatives from IMA member firms, three fund data providers including the company that monitors the sector definitions and IMA staff. It meets once a month.
The SC contributes to the development of the sectors and oversees manager requests in relation to classification or monitoring issues which are non-routine.
Q4. How are funds in IMA sectors monitored?
The monitoring process involves an analysis of the portfolio holdings of a fund to check that each fund meets the parameters of the sector and therefore may be compared with other funds in that sector. To do this, IMA has appointed an independent third party, Morningstar, to collect data directly from the fund managers, analyse it and report to the IMA on funds which appear to be in breach of the sector criteria. Additional data on the economic exposure of a fund may be collected, as necessary.
IMA undertakes the enforcement function in relation to funds’ compliance with the sector criteria, based on the reports prepared and submitted by Morningstar. Funds which do not meet the sector parameters are removed.
The nature of the monitoring process is such that at any particular time a fund may be non-compliant. Monthly reporting introducesf a measure of delay and at times follow-up and clarifications may show a fund was in fact compliant or cause it to become compliant. Sector monitoring does not provide a real-time verification of compliance nor does a breach of sector criteria inexorably lead to removal if rectified.
IMA also responds to “whistle blowing” (usually by other fund providers) with regard to funds within the sectors that appear to be breaching sector definitions.
The monitoring process does however present challenges, particularly since the introduction of widened investment powers in UCITS3 legislation. A circular (003/07) was issued in 2007 drawing attention to some issues relevant to monitoring.
Q5. How are the sector definitions enforced?
IMA undertakes the enforcement function in relation to funds’ compliance with the sector criteria, based on the reports prepared and submitted by Morningstar. Funds which do not meet the sector parameters are removed following the procedure set out in the SC Terms of Reference.
Q6. How is consistency maintained for Sectors Committee decisions?
The IMA maintains records of precedents set in relation to the sectors. These are used by the SC to inform their decision making. In respect of new issues arising, the committee will discuss and tease out the issue. They may then ask the fund company for more information before reaching a decision.
Q7. Is there a right of appeal in respect of sector decisions?
Sector issues are dealt with initially by IMA staff. If a fund company does not agree with a decision made by staff, this is referred to the SC. The decision reached by the SC is binding, although the SC will usually consider any new information that the fund company brings forward in relation to the sector request.
Where IMA staff put a decision directly to the SC (usually because the issue is complex or new), then the SC will usually allow one appeal against the decision reached.
Monitoring
Q8. Are investment trusts treated as equity assets for monitoring purposes?
As a rule of thumb, Morningstar conduct a “look through” to the underlying assets of an investment trust, in much the same way as they monitor fund-of-funds. They then aggregate from the bottom up to ascertain a portfolio’s exposure to each asset class.
IMA issued a circular (092/05) in relation to the treatment of property assets which includes investment trusts. (This guidance should also be treated as having general application to other asset types that are held within the legal structure of a security.)
Investment trusts which operate to produce absolute returns may, depending on specific circumstances, be treated as “other” assets for monitoring purposes. Further information should be sought from the monitoring company.
Q9. How are fund-of-funds asset exposures calculated?
Fund-of-funds are required to comply with the sector definitions in exactly the same way that single funds have to. For example, where a fund-of-funds is classified to the UK All Companies sector it will be required, through its investment in other funds, to maintain a minimum 80% exposure to UK equities. Morningstar will establish compliance with the minimum holding by “look through” to the assets held by the underlying funds. Therefore an equity holding in an underlying fund will be treated as an equity within the fund-of-funds; and a cash holding in an underlying fund will likewise be treated as cash within the fund-of-funds.
Q10. How are hybrid assets such as convertibles, preference shares and permanent interest bearing shares ("PIBs") treated for monitoring purposes?
Most IMA sectors require a minimum 80% investment in a prescribed “core”, whilst providing freedom in the “non core” element of the definitions. In general, the SC feels that assets that may be contentious in terms of asset type should be held in the non core element of the portfolio. Legal structure will often be the main basis for assignment to an asset type. However, clarification of treatment can be sought from the monitoring company.
The Fixed Income sector definitions make specific reference to the treatment of these types of assets for compliance with the parameters. Again, any questions may be raised with the monitoring company.
Q11. How are ADRs/GDRs treated in the regional equity sectors?
An ADR (American Depository Receipt) or GDR (Global Depository Receipt) represents the ownership in the shares of a foreign company trading on another major exchange such as the US or London. The geography of the primary exchange listing of the underlying is used as the basis for determination of an asset’s geographical classification.
Q12. How are dual listed stocks treated?
The geographical classification of a dual listed stock can be chosen by the firm, but should be communicated to the monitoring company as it may impact on compliance. Some companies issue shares that are specific to particular geographic locations and the monitoring company will take this into account.
Q13. How are derivatives handled in the monitoring?
Currently the monitoring company conducts a “look through” to the underlying where this is possible. Under regulatory rules all positions should be fully covered and this is accounted for in allocating a weight to the derivative position.
When cash (being a risk free asset) is held as cover, then a “look through” will apply. When another asset is held as cover, such as a bond, which may itself be subject to risks (credit, interest rate, counterparty), then the gross exposure to each asset category will be used to determine exposures.
Here are 3 examples of how the monitoring would currently assess exposures:
1. 10mn in equity futures, 10mn in cash (cover) = 100% in equities
2. 10mn in bonds, 10mn in equity futures, 10mn in cash (cover) = 50% in bonds, 50% in equities
3. 10mn in bonds (cover), 10mn in equity futures = 50% in bonds, 50% in equities
To assist in the monitoring of a fund’s true economic exposure, a self certified assessment of the fund’s asset allocation should be supplied to the monitoring company by the firm at the end of each month in addition to the normal portfolio holdings data.
Q14. How is an assessment made of a bond's geographic exposure?
In the fixed income sectors the domicile of the issuer of a bond is secondary to the currency in which the bond is issued, or any hedging strategy.
For example, a US corporation could issue Sterling denominated debt which could be used to contribute to the core 80% in the £ Corporate Bond sector (providing it met the investment grade requirements). Equally, if a fund purchased the debt of the same US corporation issued in US$ but the manager hedged the investment into Sterling, this then would also count in the monitoring towards the 80% in the £ Corporate Bond sector.
Q15. In the £ Corporate Bond sector, which type of assets are considered to be corporate bonds (other than vanilla corporates)?
Supranational debt and government backed debt may contribute to the “corporate” assets. Gilts and non-UK sovereign debt may not.
Q16. How much can a Europe ex UK fund hold in UK equities?
Firms are reminded that, whilst the sectors provide freedom in respect of investment in the non-core element of the definitions, the investment strategy adopted must be transparent to the end customer, appropriate to deliver on the fund objective and take account of the firm's TCF (Treating Customers Fairly) obligations.
With this in mind, funds are monitored so that the core 80% has to be invested in European equities but up to 5% of the total assets of the fund can be invested in UK equities. After this the fund becomes considered within the Europe Inc UK sector (subject to meeting the other sector requirements).
The same concept will apply to other sectors such as Asia Pacific ex Japan.
Regulatory
Q17. Does the Treating Customers Fairly ("TCF") initiative have any relevance to sectors?
Yes it does. The sectors aim to group funds that are similar so that like-for-like performance and other comparisons can be made. So if a fund is in the wrong sector, perhaps because the investment strategy would better suit it to another sector, then that could mean that a consumer may not be making fair comparisons between funds.
Firms are also reminded that, whilst the sectors provide freedom in respect of investment in the non-core element of the definitions, the investment strategy adopted must be transparent to the end customer, appropriate to deliver on the fund objectives and take account of the firm's TCF obligations.
Version 9: January 2012