However keen you are to diversify, be wary of overdoing it
IT’S BEEN a tough year for some fund managers. Missed opportunities in tech shares and bad bets on financial stocks have seen 85 per cent of active large-cap stock funds lag their benchmark indices through to 25 November of this year. Lipper, which did the analysis, said it’s probably the worst comparative showing in 30 years. So with investor patience worn a little thin, what should you consider when it comes to picking funds?
First, remember your investment aims. If you’re going active, it’s easy to get lured in by fashions and short-term performers, but you’ll probably just end up with a “messy portfolio” that doesn’t fit your risk profile or objectives, says Tilney Bestinvest’s Jason Hollands. This year has seen a love affair with UK equity income funds, for example – but really it’d make more sense to achieve some balance through small and mid-cap income funds or global equity income stocks, rather than layering exposure to the same underlying companies, he says.
But although having a diversified portfolio remains the golden rule, it is easy to get carried away and over-diversify when fund-picking, says Hollands, choosing, for instance, a new fund or selection every tax year. “You shouldn’t have more than 20 funds maximum, which you might top up each year.” By giving yourself a limit, you’ll be forced into reassessing existing holdings in order to make way for a new candidate.
With a new fund, it’s also important to consider all the major structures available, whether it is open-ended, an investment trust or an exchange traded fund, for example. Both open-ended funds and closed-ended funds can be good vehicles for growth and income, says Danny Cox of Hargreaves Lansdown, as they pool your investment, “giving you the benefit of professional management and diversification.” Investment trusts can be useful if you’re looking for a regular source of income – for schools fees, say – as they can smooth their dividend flow to investors and also borrow, which can accelerate returns. But it’s worth remembering, says Cox, that “they are pound for pound a higher risk” – so better for specialist rather than core holdings.
And while there is no hard and fast rule when it comes to which structure is better suited for income or growth at the moment, says Hollands, demand for income-generating investments has pushed many higher-yielding investment companies to premiums, so “the reality is that there are more income opportunities available in the open-ended funds world”.
A “core and explore” approach could be a way forward, says Cox. Investors split their portfolio (typically around 80-20) between major market investments and more niche areas, like small companies or infrastructure. This approach also helps keep charges down, with the core comprised of low-cost tracker funds, for example.
RIGHT MAN FOR THE JOB
It might seem reasonable to buy a fund that performed well last year or the one that has posted the highest return for the current year, says Maike Currie of Fidelity Personal Investing, “but this can be a huge mistake”. Past performance by itself gives no indication of future performance – it’d be “like driving a car looking solely in the rearview mirror,” quips Hollands.
Think about two things when looking at a manager’s record, he says: one, ask whether past strong returns have been driven by the market environment. And two, try to identify the value added by the manager over and above general market movements – along with the fees charged. Looking beyond five years will help give you a bigger picture – is it consistent delivery, or just a lucky streak?
Once you have invested, it’s vital to closely monitor your funds. The reality is that many do disappoint over the long run, and some substantially underperform, says Hollands. The latter group are often referred to as “dogs” – so-called because they’ve underperformed for three consecutive years and have seen a margin of failure of more than 10 per cent against their benchmark index.
But it is worth remembering that funds can have hiccups, despite red flags. A change of process, new manager or investment style could impact in the short-term, says Hollands, but be a better option for the future. So “don’t just knee-jerk sell”.