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Experienced Investor

What do fund managers do and how can you spot a good one?

Cherry Reynard
Written By:
Cherry Reynard

Investment funds are often the first port of call for someone starting out in investment, but how can you pick a good one?

Investors have two main options when it comes to finding a fund: active or passive management. In ‘passive’ management’, the fund will simply track the ups and downs of an index such as the FTSE 100. In ‘active’ management, a fund manager sits at the helm, using their skill and judgement to buy those stocks they believe are likely to go up over the long term. Fund managers will generally strive to beat a specific benchmark, the FTSE All-Share would the most common for UK-focused managers, for example.

Each manager will tend to operate in an individual sector: Europe, the US, emerging markets, or have a dividend or smaller company focus. Equally, each manager will have a different philosophy, their own 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 into the new Apple or Amazon as it rises.

In theory, fund managers should be able to protect investors’ capital if the market threatens to turn down, whereas passive funds have no intelligent oversight and will simply track the market lower. The best fund managers have added significant outperformance for investors over time, the worst have lost investors plenty of capital.

How should you pick a good one?

1) 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, though some of the ratings providers – Morningstar or Financial Express – offer even more granular definitions. 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 look good compared to their peer group over three or five years. There are exceptions, where strong managers have longer periods of weakness, but there are enough good managers elsewhere on which investors can focus their research attentions.

3) A good fund manager will have a strong, well-defined investment style – investors need to understand what a fund manager is doing 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 or whether there is more at work.

4) Fund managers should have a supportive environment – a fund manager with a long tenure at the helm of a fund is generally a good sign. It means they are happy, and the fund management group is happy with them. Investors should look for stability from their investment manager, not one who is going to change management groups frequently; this can be very disruptive. 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, they should be able to tell you why and what they is going to do about it. 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.

Picking strong managers is an art not a science, but fortunately a number of experienced fund managers keep rising to the surface and often, they are not too hard to spot.