How to pick an investment fund
Here are the 12 most important things I believe you should look for when picking an investment fund.
- Manager rating – there are a number of rating systems out there, such as Citywire’s which attempts to evaluate an investment manager’s performance. Citywire give managers who have a better than average performance an A or AA rating. While an AAA rating is only given to the top 5% of UK fund managers. The rating takes into account the level of risk each manager has taken as well as their performance against their benchmark over the preceding 3 years. So check the fund manager’s rating for a subjective yet effective steer as to whether they are any good.
- The fund’s fees and expenses – Research has shown that ‘Low-cost funds outperform high-cost rivals every time’. Investment companies work on the premise that their high fees are justified by their fund’s superior investment returns. The problem is that this simply doesn’t stack up in reality. The aforementioned research paper concludes that investors should make ‘cost’ a primary test in fund selection as it is still the most dependable predictor of performance. Start by focusing on funds in the cheapest or two cheapest quintiles, and you should hopefully be on the path to success.
- Active or Passive? - A separate research paper has shown that active managers take extra risk and follow the latest trends when things are going badly in pursuit of returns. When the going’s good investment managers seem to do well but when things go badly they under-perform simple indexed passive funds. Not exactly what most investors would want to pay for. The conclusion? Base the core of your portfolio around tracker/passive funds. The added benefit is that passive funds are far cheaper than actively managed funds, which relates back to point 2.
- Sector and manager’s remit– It’s important that you know what a fund can and does invest in. If you want exposure to Far Eastern equities then there is little point picking a UK corporate bond fund. But perhaps more importantly is don’t judge a book by its cover. This has been beautifully illustrated by the latest £7.7millon fine handed to Barclays by the FSA for advice relating the AVIVA Global Balanced Income Fund and the AVIVA Global Cautious Income Fund. Fund categorisation can also be misleading. For example Cautious investors might, unsurprisingly, turn to Cautious Managed funds, but, under the rules of the Investment Management Association (IMA) cautious managed funds can invest as much as 60 per cent of their assets in equities, but only need to have 30 per cent or more in safer fixed-interest investments, such as gilts and cash. This might not be cautious enough for some investors. Also consider what impact the fund will have on your overall portfolio’s asset allocation and risk. If you are picking a fund to compliment others within your portfolio from the same sector, e.g. UK equities, is the new fund sufficiently different to your existing ones to offer some form of diversification? Diversification reduces a portfolio’s risk – duplication does not Fundslibrary.co.uk is a fantastic free online resource which allows you to easily compare and contrast funds.
- Consider a fund’s portfolio turnover rate. A fund’s portfolio turnover rate measures the how often a manager buys and sells securities. A high turnover rate indicates that the manager does not hold on to stocks for very long. This may indicate active management but on the flip-side it can lead to higher trading costs and indicate a short term investment approach. By contrast a low turnover rate would indicate a manager with a long term buy and hold view to investment.
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The remaining tips from this article include:
- How to review performance and technical risk ratios – explaining in simple terms what and how to use ratios such as Alpha, Beta, Volatility, R-squared and Sharpe
- Gearing - what it is and why you need to consider it
- Manager longevity – why manager tenure is crucial
- Investment insight – how to get an insight into the future investment style of a fund
- Importance of diversification within a fund
- Size and age - why you need to consider the size and age of a fund