Five steps to picking the right funds
With more than 3,000 investment funds and a further 400 or so investment trusts available in the UK, covering a huge range of objectives, asset classes, company sizes and geographical locations, the toughest call is choosing between them. So how should you go about it?
By this stage of the Moneywise Investment School you should have a clear idea of your attitude to risk, the asset classes you favour and the sectors most likely to meet your needs. But before you draw up a shortlist of potential investments, bear in mind a few golden rules.
Arguably the most important is to spend more time researching managers than the funds themselves. Managers can switch jobs frequently and this may impact upon a fund's performance track record. It could be dangerous, for example, to be seduced by a fund's stunning 10-year returns if the present manager has only been at the helm for a few months.
Another rule is to ignore fashions and trends. Investing should be done for the long term, so avoid the temptation to buy into a particular sector or fund on the back of a spike in popularity. Never forget the lessons of the dotcom crash and the collapse of technology funds that had attracted huge amounts of cash.
Step one: What are the best sources of information?
The good news is that it's never been easier to obtain information on individual funds and their managers. The bad is that there is so much data freely available on the internet that it can be hard to find reliable, unbiased sources.
You can find a whole lot more in magazines and newspapers. The challenge is to make sense of all this information, establish reliable sources and use their insight to help you make investment decisions.
Of course, as a private investor you won't enjoy the same level of access to fund information as investment professionals. However, there are still some useful sources of data that you can access easily.
Among the best websites to check out for performance and analysis of fund holdings are Trustnet (trustnet.com) Morningstar (morningstar.co.uk) and Interactive Investor (iii.co.uk). Citywire (citywire.co.uk) and Bestinvest (bestinvest.co.uk) both publish helpful career records that can help determine whether a manager's recent performance numbers are just a fl ash in the pan. Investment houses also publish a range of information for investors on both general themes and specific funds.
Step two: What to look for in a fund
We are presuming you have already identified which of the many sectors - as defined by the Investment Association and the Association of Investment Companies - you want to invest in.
As a retail investor, your shortlist of potential funds should be from established fund management groups with the financial resources to back their managers. Then use the websites already mentioned to look at the investment track records of individual managers.
Ideally you want someone who has delivered consistently decent returns over various time periods - and who has managed funds in a variety of market conditions.
One tip is to compare funds on their performance in different calendar years. You can then see, for example, how they have done during dire periods such as 2008 when the credit crunch bit, compared with the recovery period in 2009.
Try also to understand why performance figures of various funds differ. Go through the holdings - fact sheets outline the 10 largest positions as well as other allocations, such as geography - and compare the best and worst performers.
Then look at the manager's investment philosophy, objective and investment approach. For example, some managers trade their holdings much more frequently than others. Some pay more attention to the economic situation of a particular country or region ("top down" stockpicking), while others are mainly interested in the qualities of the individual company ("bottom up").
There is no right or wrong managerial style, but you need to feel comfortable with that approach. See also if you can find out key information such as whether they invest their own money in the fund, as those who do have a vested interest in its success.
Step three: Understanding fund performance
Of course, past performance also needs to be considered but placing too much emphasis on short-term past performance is the biggest mistake an investor can make.
All investment funds have any returns periods when they perform well and others when they do badly. But managers may underperform because their particular investment style or region of focus is currently out of favour, rather than because they've made poor investment decisions. To see if that's the case, look at how their sector rivals have performed - you may find that the manager in question has actually lost less money than others running similar portfolios.
Another crucial question is who has been responsible for past performance. A fund may have been dire for the past five years but the current manager may have taken the reins only a few months ago and has yet to make their mark. In such cases, find out how they performed in previous posts.
When reviewing past performance look at year-on-year data - known as discrete data - rather than figures for several years in total. This will help you determine how consistent the manager has been from year to year, otherwise one exceptionally lucky 12-month period could mask several years of bad calls. In addition, compare performance against similar funds and relevant index benchmarks, to get a feel for whether the manager has above average abilities or is being left behind by rivals.
Step four: Factor in costs
A combination of one-off levies, ongoing charges, trading costs and in some cases performance fees can take a significant chunk out of any returns. We covered fees in depth in a previous investment school (see moneywise.co.uk) but here's an example to illustrate the effect.
Take an investment amount of £10,000 and assume growth of 6% per year, before charges. With no annual charge your original investment amount would be worth £17,908 in 10 years' time. However, an annual charge of 1% would bring that total down to £16,289, while a 2% annual levy would reduce it even further to £14,802, according to data compiled by AWD Chase de Vere.
So do look at a fund's costs before you buy. You can keep them down by going through a discount broker or fund supermarket.
Step five: Making your decision - and monitoring your choices
Consider diversifying your investment across a number of funds to lessen the impact of any one fund doing really badly. Remember, there are no guarantees of success in this business, and numerous political and economic unknowns can affect your returns.
A vital part of the process involves monitoring your choices so read the monthly updates from the company and the opinion of financial advisers in the press. Doing so will alert you to periods of poor performance. Should these occur, don't automatically switch to another fund because there may be justifiable reasons for returns to be disappointing - and they may be nothing to do with the fund manager's skills.
But if a fund starts losing money, it's time to scrutinise its performance. The figures may be a consequence of dramatic market or sector circumstances - but what's the longer-term outlook? Thorough research is key to investment success so find out what's happening before you jump in.
Usually charged as a percentage of returns for performance above a specified benchmark, such as an index. The fee can range from 10% to 20% of total investment returns on a low starting benchmark such as Libor and investors could find themselves paying extra fees for merely average performance. Note that these funds do not compensate investors when the manager underperforms the benchmark.
An individual employed by an institution to manage an investment fund (unit trust, investment trust, pension fund or hedge fund) to meet pre-determined objectives (usually to generate capital growth or maximise income) in prescribed geographic areas or investment sectors (such as UK smaller companies, technology or commodities). The manager also carries the responsibility for general fund supervision, as well as monitoring the daily trading activity and also developing investment strategies to manage the risk profile of the fund.