How to Pick a Winner…

Last month’s article focused on the cost of inertia and the danger of leaving money in investment funds that provide unsatisfactory performance. This time round, we suggest how you can identify a better home for your money.

How important is it for a fund to clearly set out its objectives?
I think it is crucial, there should be no ambiguity as this could allow a fund manager to stray beyond their expertise.

Furthermore, if you are constructing a complex portfolio the remit of the fund must match your requirements. For instance if you want exposure to one geographical area, say Latin America, a more generalist emerging market fund might not, over the long term, satisfy this requirement. The fund may have a high Latin American exposure when you initially invest but there could be a change of direction further down the road if, for instance, the manager pulls out of the region and instead becomes heavily exposed to Asia.

Should investors look for consistency of performance over a meaningful period rather than a snapshot of one or two stellar years?
Absolutely, consistency of performance over a meaningful period is a good way to gauge competence. Cumulative performance figures can be misleading as you could have a fund which shows a strong 10-year return but all of that return could have materialised in one 12-month period and therefore flatter 9 poor years. Ideally you want to identify a fund that is better than average within its peer group over a number of consecutive years.

Is there a benefit in understanding a bit about the company you are entrusting your money to?
It is important to be clear about how important fund management is to the company. Companies that only manage money don’t have other distractions. Success depends on whether they are able to deliver good returns. Consequently they have little option but to commit resources to research and analysis.

Ultimately, for a fund to perform well consistently it needs a dedicated group of high calibre people to run it. In any organisation there is competition for resources and if fund management is only one part of a company’s business, there is always a risk that money and people will be allocated to other areas.

You often hear the terms ‘star managers’ and ‘investment gurus’. Are these titles always justified and should investors pick funds based on the person at the helm?
I am wary of these labels. You do often hear the term ‘star managers’ but sometimes these ‘stars’ perform well because of the strength of the research team around them. If you take the manager away from this support structure they can often struggle. It is therefore dangerous to blindly ‘follow’ a manager as there are no guarantees that he or she can replicate good performance when they move to a competitor.

Success is not just about individual flair. It is quality of information that gives fund managers the edge and this quality of information depends on having the people and resources in place. The successful fund managers tend to enjoy better access to the boardrooms of the companies in which they invest (usually because they are significant shareholders); this is a distinct advantage as they are able to look beyond the hard numbers in an annual report.

Presumably if you are paying for active fund management, you want a fund manager that invests with conviction and is not interested in hugging a benchmark?
As far as investment style is concerned it is important to be sure that you are getting what you pay for. Very active funds tend to have higher running costs. Investors looking for genuine active management should look for a fund that is prepared to be contrarian and follow its own ideas rather than those of the herd. Beware of paying fees for active management and only receiving only a passive experience.

For some funds it would appear to be more important not to be bottom of the table than to be at the top. This is a dangerous philosophy as it means managers are not coming up with new ideas, instead they are just following the index (or what their peers are doing).

Most good funds allow managers the flexibility to manage in their own way; by this I mean the manager’s bold investment ideas are not always vetoed by the risk management department. An experienced IFA will know which companies put unfair constraints on managers and effectively put a brake on entrepreneurial activity.

Should investors identify what a fund management company’s core strengths are?
Yes, I think they should. There are lots of ‘me too’ funds, funds which are launched simply because a particular investment theme or objective is in vogue, not because the management company has any specific expertise. Slick marketing is all very well but if it is not backed up with resources and a serious intent, the fund will probably never amount to much.