Currently there are around 2,500 open-ended funds for sale in the UK plus another 400 or so investment trusts.

Fortunately, there are a number of resources available to make the decision-making process less daunting.

One such resource is fund rating firms. Companies such as Morningstar and FE Trustnet (many execution only brokers also provide their own ratings tools) carry out in depth, independent research into funds, analysing how they have performed compared to their peers and and the index in different market conditions.

One big advantage is rating firms have information that private investors do not readily have access to and they keep a close eye on any issues that may affect a certain fund.

Rating firms also help investors avoid falling into the trap of simply picking the fund with the best past perfomance.

They evaluate a fund’s performance on a relative and absolute basis which can go a long way to establish whether good performance is just a one-off flash in the pan or likely to continue.

Adrian Lowcock from Hargreaves Lansdown says: “These lists are extremely useful as they are thousands of funds and trying to sort out the wheat from the chaff is not as easy as looking at the past performance of the fund. A rating list is there to help narrow down the huge amount of choice there is available for individual investors.

When picking which firm to use it is important to consider what goes into making the rating.

“Past performance is a factor but it is the long term performance that matters most,” says Lowcock.

“Investors need to be careful not to put too much faith in short term performance tables or lists that promote the best performing funds. It is more important that the funds being rated consider the fund manager’s track record.”

It is also important to remember that managers move firms and take their experience with them.

“It is this experience that counts so follow the manager not the fund,” Lowcock recommends.

Analysis can also determine how much value the manager is actually adding to the fund.

For example, rating firms look at a fund’s holdings and determine which investments contributed to performance and whether the changes the manager has made has added value or not. This is useful as it helps to identify the manager’s style and abilities.

However, although rating firms are considered important tools in the fund picking process, investors should note they do have some disadvantages.

Due to the lengthy process of becoming a highly-rated fund, lesser known funds may not be recognised in their early period.

And while it may seem convenient to choose your investment funds based on favourable analysis from a rating services, these ratings are not set in stone and are subject to change depending on performance.

This makes it necessary to review investments regularly to check that the outlook for funds remain the same as when you invested.

So while independent fund ratings can be helpful sources of general information about a fund, investors should be wary of putting too great an emphasis on the ratings when using them to pick a fund.

Over the page: which ratings firm to use…

Ratings agencies

Morningstar OBSR

Services: Analyst research and analyst ratings (open-ended funds, closed-ended funds, equities); ETF research; investment consulting (managed portfolios, model portfolios, select lists, asset allocation).

Key features: Large research and consulting team with approximately 30 fund analysts in the UK. Has the ‘Star Rating’ as well as the Qualitative rating scale: which is tiered by Gold, Silver, Bronze, Neutral, Negative. Gold to Bronze for funds that analysts believe have sustainable advantages on a risk-adjusted basis over a full market cycle. Morningstar ratings are reviewed on a monthly basis.

Note: Star Ratings are a useful tool for identifying funds worthy of further research, but shouldn’t be considered buy or sell signals. 

FE Trustnet

Services: Analyst research and ratings on IMA unit trusts and OEICs, equities, ETFs, VCTs, Offshore funds, Investment trusts, pension and life funds.

Key features: price and performance data is provided daily for all funds where available, with fund data and information filled by its in-house research and data.

FE Crown Fund Ratings ranging from one to five and are awarded based on the fund’s stockpicking, consistency and risk control. A single FE Crown Fund Rating reflects the lowest tier, and suggests the fund has failed to impress on the above terms, while a five FE Crown Fund Rating reflects the highest tier and identifies a fund which we think is of superior quality.

Coming soon

FundCalibre

Services: Set to launch early next year, FundCalibre will be a web-based fund rating service and research platform, initially covering open-ended funds. The 50/50 joint venture will be headed up by Albermarle Street Partners’ three founding partners Dan Kemp, Clive Hale and Sam Liddle, as well as Chelsea Financial Services’ managing director Darius McDermott and research director Juliet Schooling Latter. There will only be one level of rating: the ‘Elite Fund’ rating. The research centre will include 150 fund reviews (rising to 300) and a portfolio builder.

Key features: Only funds with greater than a 60% probability of producing alpha over the next 12-month period will be eligible for an Elite Fund rating.