While interest rates on cash ISAs remain low, equity investments can be a good way to boost the returns of your ISA allowance. However, picking your own stocks can be fraught with obstacles. In this environment investing in a fund can be an attractive choice.
But what are the main benefits of investing in a fund? Diversification, knowledge and experience, says Tom Stevenson, investment director at Fidelity International. “Diversification is extremely useful as it can protect you from the market swings that can effect individual stocks. With a fund you also get the expertise of a professional fund manager.”
As you can see in the table opposite, Morningstar, the independent research firm, has found that two of the top five best performing ISA-eligible funds in the last three years were in emerging markets. But how can you best utilise your ISA to benefit from one of the biggest investment stories of the year?
The information flow from companies in emerging markets can be scarce and there are often liquidity and political issues to consider. “The challenge of picking your own stocks in emerging market nations can be enormous, and it can be too much to do on your own, which is another reason to invest in a fund,” says Stevenson.
But what should an investor look for when picking a fund? There are some performance metrics that are widely used within the fund management industry.
For a start, Stevenson recommends that you look for consistency of performance. Although past performance is not a reliable indicator for the future, you want to pick a fund with a good track record. “Take a long-term view, anyone can do well two or three years in a row, but if a fund has performed consistently over a number of years, usually more than five, that is a good sign,” he says.
The most important metric, however, is a fund’s performance relative to its benchmark, usually a stock index: “The consistency with which the fund beats its benchmark is important because it shows how good the fund manager is at picking stocks, relative to just investing passively in the market, this is where they provide a valuable service,” Stevenson adds.
The fund management business puts a lot of emphasis on the skill of the individual fund manager. “The insight and temperament of a fund manager is very important,” says Stevenson. Bolton’s success in managing Fidelity’s UK funds was in large part due to the fact that he is not afraid to go against the conventional wisdom of the market. “It can be much harder for an individual to do this when they are on their own,” says Stevenson.
It’s also important to make sure that you choose a fund that will fit in with your overall risk profile. “It’s about understanding what you’re buying, how it will perform and how it will fit within your overall portfolio,” says Jackie Beard, director of fund research at Morningstar UK.
Investors should also avoid merely following the hype that can surround some funds. “We would caution people about investing in funds that have been stellar performers for the last two or three years,” says Beard. Rather than blindly pick the top performers, dig a bit deeper to find out exactly if a fund is right for you.