Money tip #113 – Treat investment funds like used cars

3 min Read Published: 30 Nov 2010

 When it comes to picking an investment fund be it for your pension, Stocks or Shares ISA or any other investment it pays to check under the bonnet.

Check under the bonnet

The reason I say this is that a lot of investors may have the misguided belief that just because a fund calls itself a European equity fund, for example, or resides within the Investment Management Association’s (IMA) European equity sector that it invests solely in European shares. But I have news for those investors, this is not necessarily the case.

The ' IMA sectors provide a way of dividing around 2,500 investment funds into broad groups. Investors and their advisers can then compare funds in one or more sectors', which is very useful. But if you look at the definition of a ‘European excluding UK’ fund only 80% of the fund's assets must be invested in European equities to qualify. Consequently, that leaves up to 20% of the fund’s assets which can be invested largely where the manager wishes.

An investor who is fearful of the problems in Europe may purposely choose a ‘UK All Companies’ fund in the belief that they are obtaining exposure exclusively to the UK equity market and certainly not directly exposing themselves to European equities. However, if you look under the bonnet of some funds, some will invest in European equities! So the moral of this story is check what an investment fund is actually investing in before you part with your cash.

Other tips Stretching the used car analogy that bit further, there are a couple of other things you might want to bear in mind when choosing investment funds:

  • Check the owner history – one careful owner is far more preferable than a string of owners. Research has shown that the active funds most likely to outperform were those with longer manager tenures suggesting that truly skilled managers who are left alone to do their job will reward their investors.
  • Check the car has not been involved in an accident – look at the funds historical performance and volatility, particularly during the recent downturn. While past performance is not a guarantee of future returns it may pay to be cautious of managers who have a tendency to haemorrhage money when markets head south.
  • Approach the purchase with a sceptical eye – you wouldn’t take what the used car vendor has to say about the car as ‘gospel’ so similarly don’t base any investment decision on a fund’s marketing material alone. Do your own research and trust your own judgement
  • Check the paperwork and the potential running costs – read the fund factsheet and associated literature. Make sure you note the charges associated with investing in your chosen fund.

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