Four easy ways to spot tomorrow’s investment stars
An even more spectacular record was set by Anthony Bolton, who turned £1,000 into £147,000 for investors in Fidelity Special Situations under his 28-year-long tenure from December 1979 to December 2007.
However, Lee Robertson, chief executive of Investment Quorum, a London-based wealth manager, warns: “Returns like these are stellar and highly unusual – investors shouldn’t expect to make this type of return.
“Most financial planners typically project equities to return 5% to 7% a year over an investment timeframe of at least five years, but you could potentially be looking at more than double this if you manage to pick the winners.”
We ask the experts for four easy ways that investors can sift through funds to try to spot the investment stars of tomorrow.
1. Find consistently strong performers
A simple way to check the skill of a fund manager is to track a fund’s performance against its benchmark. This is usually a stock market index against which the fund is measured, published in its factsheet and prospectus. Managers who consistently outperform their benchmarks are likely to have a strong investment process, capable of delivering consistent returns.
Rob Morgan, a senior analyst at Charles Stanley Direct, says: “Using fund data websites Morningstar and Trustnet is a good way to find which funds are top performers in their sectors. These sites have the charts you need to compare funds and their benchmarks.
“Although performance doesn’t tell you whether the fund manager has been skilful or lucky, the longer and more consistent the track record the more likely it is that their skill and process are genuinely adding value. Looking at discrete years of performance, as well as longer periods, can help with this.”
Ben Yearsley, investment director of Wealth Club, a recently launched execution-only service for investors, believes fund managers need a record of at least five years before investors should consider them.
“It’s difficult in the very early years to spot a potential star of tomorrow, because over less than five years their performance could be down to luck or market environment,” he says.
“You also want managers to have been through different market environments to see how they react – do they panic in a quickly falling market or when things go against them?”
For him, a relevant benchmark is crucial. “Just because a fund is in the All Companies sector, doesn’t mean that it’s right to compare it to the FTSE All-Share index.” This is because the FTSE All-Share is heavily weighted to large companies, whereas the fund might be invested mainly in medium- or smaller-sized companies.
Mr Yearsley says investors should look for funds that have beaten a relevant benchmark by 2% to 3% over five years. But remember that while performance is an important measure, strong past performance does not guarantee future good performance.
2. Look for truly active managers
Fund managers can’t beat the benchmark index if they hold the same stocks as the index.
‘Active share’ is a measure of how different a fund is to its benchmark and can be a really useful indicator of whether a manager is truly doing something different or at least having the conviction to back a significant number of stocks that are not large constituents of the index.
Funds with low levels of active share tend to mirror or hug their benchmarks (an active share of 0% denotes a tracker fund), while those with high active share tend, in good markets at least, to outperform their benchmarks and deliver what is termed ‘alpha’. A fund with an active share of 100% is completely different from its benchmark.
Fund management groups are not yet obliged to publish a fund’s active share. However, Oliver Stone, head of research at Fairstone Private Wealth, says: “More asset managers are providing these figures on their factsheets, which can be obtained direct from their websites or from websites that allow investors to do their own research, such as Trustnet, Citywire, Tilney Bestinvest and Hargreaves Lansdown. If they aren’t published, you can usually give the asset management firm a call on their broker line to enquire.”
Comparing the performance of an active fund to an equivalent tracker fund on a chart or discrete performance table is a reasonable alternative. If they are closely matched, you could have a ‘closet tracker’ on your hands.
3. Take account of a manager's objectives and style
Check fund factsheets for their investment objective. A manager who invests in smaller companies, for example, or areas of the market which are sensitive to fluctuations in the economy, such as car manufacturers and airlines, could produce more volatile performance than their peers.
Heather Ferguson, an investment analyst at Hargreaves Lansdown, says: “Understanding what the manager is trying to achieve before investing can make it less painful to ride out any fluctuations in the fund’s value or highlight in advance that the fund is not suitable for you.”
Getting to know the characteristics of a fund manager’s investment style can also help to explain periods of underperformance. Fund factsheets or simplified prospectuses will give you a good idea of this, while investor websites and the financial press are other good sources of information.
“Fund factsheets can be very dry affairs, but try to find other communications from the fund manager that give more colour, in particular their own philosophy on investing,” says Simon Evan-Cook, a senior investment manager of Premier multi-asset funds.
Clive Beagles and James Lowen, managers of the JOHCM UK Equity Income Fund, often outperform peers in rising markets as they tend to include more economically-sensitive areas in the portfolio, while Neil Woodford, a veteran in the equity income space, has historically given better capital protection during less favourable market conditions. Neil Woodford's CF Equity Income Fund is a member of the Moneywise First 50 Funds for beginners.
“Both have outperformed over the long term, showing that it’s possible to outperform with completely different styles,” says Mr Morgan.
It is also worth checking the size of the fund, particularly when investing in less liquid areas such as smaller companies: smaller funds are more nimble and their managers more able to take advantage of opportunities as they arise than those managing larger amounts of money.
4. Follow what the professionals think
Websites Citywire, Morningstar and Trustnet have fund ratings that can help you narrow down the wide choices available. Each has research teams that meet managers in person and analyse their investment process. They also take into account many factors that ordinary investors can’t, such as team structure, investment process and remuneration.
Fund recommendation lists are also worth a look. Hargreaves Lansdown runs a ‘Wealth 150+’ list of funds with best-in-class performance potential and low charges. If you are interested in open-ended funds [where there are no restrictions on the amount of shares a fund will issue], FundCalibre looks at all open-ended funds available to UK investors (more than 3,000) and narrows them down to about 100 of the very best.
It does this by way of an algorithm that strips out the impact of market movements on a fund’s performance to leave just the fund manager’s impact, followed by an interview process to better understand what gives them an edge.
“Those who pass the interview get awarded an elite rating and are listed on our website,” says managing director Darius McDermott.
“We don’t see the point in one, two or three stars. Why would you choose a three-star fund if a five star is on offer? A fund is either ‘elite’ or not,” he adds.
Getting more technical: statistical measures
Many investors look at ‘volatility’, how much returns from a fund have gone up or down in the past. To measure volatility, you can use something called ‘standard deviation’, which is detailed on the Citywire and Morningstar websites. This shows how widely a range of returns varies from the fund’s average return over a particular period and is a good gauge of risk. A higher standard deviation figure means a fund is more volatile.
Nathan Sweeney, a senior investment manager at Architas, the multi- manager arm of AXA, gives the example of a fund with an average return of 10% and volatility of 20 over a year: the range of its returns over the period has swung from +30% to -10%.
“By looking at this measure, you can get an idea of how much performance is potentially going to jump around,” says Mr Sweeney. “It’s a useful tool to compare funds with others in the same sector or asset class; there’s no point in taking on higher risk than necessary to achieve the same reward.”
Another measure of volatility is Sharpe ratio, which calculates the level of a fund’s return over and above the return of a notional risk-free investment, such as cash or government bonds. The higher the Sharpe ratio the better; as the ratio increases, so does the risk-adjusted performance.
“In effect, when analysing similar investments, the one with the highest Sharpe score has achieved more return while taking on no more risk than its competitors,” says Mr Sweeney.
Read Four potential investment stars of tomorrow to see who you should be taking note of.
A document which describes and advertises a new share issue or flotation (IPO in US) to potential investors, the contents of which are regulated by UK company law, the Financial Services Authority (FSA) and the London Stock Exchange. The prospectus should include details such as a description of the company’s business, financial statements, biographies of executives and directors, detailed information about their remuneration, any current litigation, a list of assets and other information deemed relevant for consideration by a prospective investor.
The term is interchangeable with stock exchange, and is a market that deals in securities where market forces determine the price of securities traded. Stockmarket can refer to a specific exchange in a specific country (such as the London Stock Exchange) or the combined global stockmarkets as a single entity. The first stockmarket was established in Amsterdam in 1602 and the first British stock exchange was founded in 1698.
All investment returns are measured against a benchmark to represent “the market” and an investment that performs better than the benchmark is said to have outperformed the market. An active managed fund will seek to outperform a relevant index through superior selection of investments (unlike a tracker fund which can never outperform the market). Outperform is also an investment analyst’s recommendation, meaning that a specific share is expected to perform better than its peers in the market.
An interchangeable term for shares (UK) or stocks (US). Holders of equity shares in a company are entitled to the earnings and assets of a company after all the prior charges and demands on the company’s capital (chiefly its debts and liabilities) have been settled. To have equity in any asset is to own a piece of it, so holders of shares in a company effectively own a piece proportionate to the number of shares they hold. (See also Shares).
Describes the relationship between a client and a stockbroker or independent financial adviser whereby the broker or adviser acts solely on the client’s instructions and doesn’t offer any advice on which shares to invest in or financial products to buy and simply “executes” the wishes of the client, regardless if they are judged to be sound or wrong. Other types of broking service offered are advisory (whereby the client/investor makes the final decisions, but the broker offers advice) and discretionary (whereby the broker manages the portfolio entirely and makes all the decisions on behalf of the client).
A standard by which something is measured, usually the performance of investment funds against a specified index, such as the FTSE All-Share. Active fund managers look to outperform their benchmark index. Cautious fund managers aim to hold roughly the same proportion of each constituent as the benchmark, while a manager who deviates away from investing in the benchmark index’s constituents has a better chance of outperforming (or underperforming) the index.
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.