Investors have two main options when it comes to finding a fund: they can choose a fund that simply tracks the performance of an index, a ‘passive’ option, or they can pay a fund manager to sit at the helm and select the right companies. For this ‘active’ approach, a fund manager uses their skill and judgement to buy those stocks they believe are likely to go up over the long term. Fund managers will try to generate better returns than that delivered by the index.

Each manager will tend to focus on a specific sector: Europe, the US, emerging markets, or have a dividend or smaller company focus. They will have their own philosophy, a strategy for beating the index: Some believe it is best to try and find those companies on the cheapest valuations on the basis that they are buying at its lowest point. Others seek to find companies with the fastest growth rates, aiming to buy the next Apple.

The trouble is, some are good and some are bad. The good can be very good and add significant returns for investors over and above those of the index. Also, they have been able to protect investors’ capital as the market threatens to turn down, whereas passive funds have no intelligent oversight and will simply track the market lower. However, the worst managers have lost investors plenty of capital, so investors need to pick with care. What should they bear in mind?

1) No-one is a genius all the time. Every fund manager has good and bad times. The key is to identify a manager that is the best among his peers. In this, the IMA sector groupings will help. They group funds according to their investment strategy – Europe, UK dividends etc – so investors can compare. Investors need to be confident that the manager they choose has been measurably better than other managers who are trying to achieve the same goals, or have the same benchmark.

2) Top fund managers may not perform well all the time, but they will have good long-term performance. They may have a bad year, but they should still look good compared to their peer group over three or five years. There are exceptions, but good managers usually stay good and, in particular, bad managers usually stay bad.

3) A good fund manager will have a strong, well-defined investment style – investors need to understand where a fund manager is investing on their behalf. They should understand whether they are going to be invested in economically-sensitive areas of the market such as banks or industrial companies, or steadier blue-chip companies that pay high dividends. This will help investors understand whether a manager has had a period of good or bad performance simply because their strategy is in or out of style.

4) Fund managers should be backed by a good company – investors want a happy fund manager who isn’t going to decamp to another firm. A fund manager with a long tenure at the helm of a fund is generally a good sign. Investors should look for stability from their investment manager. Also, some groups have a strong culture that enables managers to thrive and perform well.

5) Managers should be open and honest – if a manager has a poor period of performance, he should be able to tell you why and what he is going to do about it rather than hide behind performance figures. Equally, managers who act responsibly when their fund is doing well – capping the size of the fund, for example – tend to perform better over the longer-term.

One tip is to look at those managers favoured by some of the multi-managers such the teams at F&C Investments or Jupiter. They have lots of experience in picking the best managers and know what creates a winner.

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