How do experts choose funds?
Here are some of the key characteristics to look for when selecting funds.
- Consistent performance
It is often argued a large proportion of funds fail to beat index trackers, which simply aim to replicate the performance of a particular market. There is some truth in this, and it is partly down to the higher charges associated with actively managed funds.
However, a significant number do outperform and sometimes on an impressively consistent basis. The tricky part is discerning whether a fund manager has been skilful or just lucky. We like to analyse a manager’s performance through an economic cycle, typically over 5 to 7 years, to better understand when and how they outperform. Stellar shorter term performance isn’t necessarily a reason to buy and should be analysed in the context of sector and/or geographical positioning.
Even the best fund managers have poor periods. There were occasions, for instance, when Neil Woodford’s conservative stance saw his funds lag behind his peers before delivering strong returns.
Over extended periods, though, managers show their true colours. The fact fund managers change jobs complicates the picture, but it is useful to look back at an entire career rather than just the latest fund. Remember too while experience counts for a lot in the fund management industry, every manager has to start somewhere – we also look for outstanding younger managers coming through.
When considering the performance of a fund it is worth bearing in mind the approach of the fund manager. Some managers are more aggressively bullish and predisposed to outperform in rising markets. Others tend to protect capital better during less favourable market conditions.
Blending funds with different outlooks can create diversity and help construct a balanced portfolio. Looking at this can also help put performance into perspective. For instance, if the ‘style’ of the fund is conservative and contains predominantly solid, resilient businesses, it is likely to underperform in a market rally led by more economically-sensitive shares.
- What’s under the bonnet?
The finer detail of how a fund is constructed is also important in explaining performance. High yielding stocks often perform differently to low yielding growth stocks, and certain sectors outperform others at different times – for instance financials have generally fared well this year while mining stocks have languished.
It is important to compare apples with apples, especially in a broad sector such as the IA UK All Companies. As well as funds concentrating on the FTSE 100 this sector contains funds invested predominantly in smaller or medium-sized companies, which may perform very differently.
Bigger doesn’t necessarily mean better, but it can be a help at times. Larger organisations such as Fidelity, BlackRock and Schroders have vast global coverage, employing numerous analysts to scour the various different markets for shares with the most upside potential.
While analyst coverage is important to feed fund managers with ideas it isn’t the be all and end all. The key is how it is used. The fund manager still has to make the right decisions with the information available, converting research into returns. Some managers thrive without employing vast numbers of analysts, finding maintaining a close-knit team of trusted individuals works better.
As in all professions, fund managers will generally be attracted to firms that recognise and reward their expertise. This doesn’t just mean the incentives of remuneration or a stake in the business, it can also mean less tangible aspects such as the freedom to implement their own process. This can lead many managers to join, or even found, smaller boutique fund management groups where they can pursue their own investment style without having to conform to any “house view” imposed by a large organisation.