What are Outcome Oriented Funds?

Morningstar fund analyst Randal Goldsmith on the rise in popularity of target return funds and how investors should view them

Emma Wall 22 February, 2017 | 12:06AM
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Emma Wall: Hello, and welcome to the Morningstar series, 'Ask the Expert'. I'm Emma Wall. I'm joined today by Morningstar's Randal Goldsmith.

Hello, Randal.

Randal Goldsmith: Hi, Emma.

Wall: So, what is an outcome-oriented fund?

Goldsmith: Okay. So, an outcome-oriented fund is a fund that's managed to a specific objective, be it a target return, target risk, or target income as distinct from traditional multi-asset funds that are managed to asset allocation ranges.

Wall: And these types of funds have hugely grown in popularity over the last couple of years. Why is that?

Goldsmith: There have been a number of factors. Bear markets can make people think more about absolute returns, target returns. The retail distribution review has been very important, particularly it's a driver of the risk targeted funds, where it's added to the responsibilities of financial advisors in terms of fact finding of the client circumstances and risk tolerances. And the end result of that is it's very convenient for financial advisors having risk profiled client to find a fund that is managed to a specific risk range as measured by something like volatility.

Wall: So, it's really just a trend of more outsourcing both by professional investors and indeed retail investors, because another reason why they might have gained popularity in the last year of course is pension freedom, so more people are post-retirement might be managing their own money, and so it's very important that we understand exactly what these funds do, because of this, this growing group of investors who will be looking to invest in them. And you've recently done a report into risk – into income – outcome oriented funds. What have you found?

Goldsmith: Okay, what we've found is that, when you look in the bonnet of these funds, they not really are different from traditional multi-asset funds. In fact, if you take almost any risk-targeted fund, if you wish to take away the label and just look at the portfolio itself, you wouldn't be able to guess that it was a risk targeted fund.

They are managing a little bit of a different way, because they are trying to achieve these objectives, the way the manager manages is, there is a little bit more course correction on the part of the manager. But as you say, the portfolio itself, it doesn't really look any different from that of a traditional multi-asset fund. And you know, when you look at it on things like charges, risk-adjusted returns, again, very, very similar.

Wall: And does that matter? I mean, if – it almost doesn't matter what the process is, as long as the outcome it delivers, does it matter that these aren't that different from the sort of more traditional multi-asset funds?

Goldsmith: Well, it depends on where you are coming from on this. But as a rater of funds, then people ask the question, do you need to put these into separate peer groups? And my argument would be, no, because the underlying portfolios are not that different. On the one hand, and on the other hand, if you do create separate peer groups, you are reducing the number of funds in any individual peer group, which reduces the significance of any risk-adjusted return comparison.

Wall: Of course, because, then if you are comparing against peers and that peer number is smaller, automatically you are going to look a little bit better in performance, aren't you?

Goldsmith: Possibly, but say the main thing is, that the significance is reduced. I mean, if you've got a peer group and these five funds in there, and the one fund has got a lot better risk adjusted performance, people will say, so what, whereas if you've got better risk adjusted performance and it's in a peer group of a 50, then yeah, that's something to take note of, you know the significance.

Wall: Randal, thank you very much.

Goldsmith: You are welcome.

Wall: This is Emma Wall for Morningstar. Thank you for watching.

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Emma Wall  is former Senior International Editor for Morningstar

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