The Specialist Open-Ended Fund Sector is the most confusing of all classifications because its constituents are so diverse. The Investment Management Association (IMA) admits that it is something of a default option for funds that do not fit the more rigid definitions of other sectors. It defines specialist funds as those that ‘have an investment universe that is not accommodated by the mainstream sectors’, before advising that ‘performance ranking of funds within the whole sector is inappropriate, given the diverse nature of its constituents’.

Yet it is impossible to ignore since it is the home to a number of funds that frequently dominate the performance tables. This should come as no surprise since funds concentrating on particular markets, regions, sectors or themes are likely to outperform more general portfolios when global economic conditions favour their particular specialisms. The reverse is also true – when their chosen area does badly, performance drops. This is a volatile sector.

Dramatic growth
It is also an important sector, accounting for just over five per cent of the IMA total in terms of both numbers of funds and funds under management. This is an indication of the recent growth of the sector. Strong performance by the sector specialist funds – first pharmaceutical and biotech funds, then financial funds and latterly property and
the natural resources funds – boosts the total assets under management and encourages new specialist funds to be launched.

The majority of the sector is very young. Of the 95 sector constituents on the Lipper database, 41 were launched in the past two years and only 28 had a track record of more than five years at the end of 2007.

The largest single sub-grouping is property funds and the majority of these were launched in the past three years. Here there is also confusion, some funds invest directly in physical property, others hold portfolios of property company shares. Some are UK focused, others are global.

They are all individuals
So how does an investor make sense of this sector? ‘The simple answer is, you do not,’ replies Anna Bowes, investment manager at AWD Chase de Vere. ‘There is no point in doing a fund versus sector comparison when dealing with specialist funds. It is a bit of a dumping ground, even more so than the Unclassified sector.’

James Davies, head of investment research at Chartwell Investment Management, feels that ‘The IMA quite rightly receives much criticism for its fund sector categories but the specialist sector is the most perplexing. Different types of commodities funds are next to different types of property funds, alongside biotech, Latin America, India, Russia and absolute return funds. It is a mixed bunch of beauties and horrors. If you ever see a fund shouting about its performance against the IMA specialist sector average, beware.’

Martyn Ingram of fund research group IPM agrees, ‘The specialist sector is badly named. It is really a place for investments that do not fit anywhere else.’

Making your own sectors
For the purposes of considering this sector we have dispensed this month with the usual Lipper Leaders analysis. This is because of the difficulty in making meaningful comparisons between funds investing in gold mines, REITs and insurance companies, and also because of the fact that nearly half of the sector have an insufficient track record to feature in the analysis.

It seems that investors looking at the sector have to break it down into its constituent parts.

Bowes adds, ‘Investors must appreciate that this is going to be a higher-risk area to get into. You can try to pick similar funds, but even that can be difficult for private investors. There will be a lot of volatility so, if you really want to get into these funds, you will need professional advice.’

She says, ‘Clearly, the performance of some funds is going to attract a lot of attention. Even something like JPM Natural Resources, which has been the best-performing fund in the whole open-ended universe recently, is not a low-risk fund. Ian Henderson is an excellent manager but if the situation turns round for commodities and they underperform, even his fund will suffer. You must not assume that, because a fund has been performing well, it will continue to.’

Considerable opportunities
Yet there will undoubtedly be constituents of this sector outperforming at any given point in time. The difficulty is working out which ones they are. Tim Cockerill, head of research at Rowan & Co, argues, ‘You could make a fascinating portfolio by going into the specialist sector alone. The specialist sector is, in some respects, the most interesting of all, because there are so many different things there. It is, however, very difficult to analyse. It is not at all homogenous and trying to extrapolate from the rankings is totally meaningless.’

He reinforces the point that ‘You cannot make meaningful comparisons from the sector numbers. You have to pull out funds you are interested in and make your own mini-sector. If you want something a bit different then you can find it here. If you want to look at the German market, there is a German growth fund, but it is hard to make any sense of it. If a fund does not fit anywhere else, then it goes into the specialist sector with the result that we never look at the sector as a whole. We always strip out individual funds and measure them against relevant benchmarks.’

Dealing with the nuances Cockerill suggests that the sector contains idiosyncrasies: ‘For my money, there are things in there that are not “specialist”, like Schroder Income Maximiser, which is designed to deliver above average income by writing covered calls.’

This DIY sector creation can be hard even for the professionals. Trust monitoring website www.trustnet.com breaks it down into six sub-sectors – natural resources, property, countries, biotech and health, financials and other – but the ‘other’ category still contains a large number of funds with very little in common, except for not fitting in elsewhere.

Even with the other accepted sub-sectors, there are wide variations. In addition to the difference between direct and share-based investments in the property sector, the ‘countries’ heading covers both single country portfolios and regional funds, not to mention the theme of the Allianz BRIC fund, which invests in the key emerging markets of Brazil, Russia, India and China, while ‘natural resources’ includes portfolios of mining shares and funds that trade ETFs based on physical commodities.

In the accompanying table, we have attempted to break the sector constituents down into more meaningful groupings, though there are cases in which funds could appear in more than one sub-grouping. This gives 18 sub-groups, several of which contain only one fund, of which by far the largest are the property funds. Concentrating on these groupings should at least mean that you can compare funds with similar objectives. Any decisions to invest in a fund within this sector will be driven as much by the prospects for its investment strategy as any analysis of its relative performance.