Those who are looking for a good investment fund, must choose from thousands. The majority of them, however, doesn’t have the right to exist, says Jeffrey Schumacher, analist at Morningstar Benelux. This is because many investment funds perform less well than a passive (and cheaper) alternative, like an ETF.
Therefore, it is important for investors to select only the best ones. Schumacher indicates three characteristics that distinguish positive funds from the poor ones. If you are composing an investment portfolio, then select funds that meet the following criteria.
1. An investment fund has low costs
The costs of an investment fund are crucial for achieving good returns. The costs of a fund come directly at the expense of the return.
The costs that come at the expense of the return, exist for a significant portion of the management fee. The size of this fees can differ significantly within the same type of funds. 0.5% difference per year seems negligible, but the compounded interest rate effect causes this difference to be significant in the longer term. Other costs that you have to account for include audit fees and marketing costs.
Together, these costs make up the current expenses, the price tag of a mutual fund. This is a percentage fee which is stated on the Key Investor Information, which can be found on the website of the fund provider. Although the percentage of ongoing charges is made up of a lot of cost components, there are also costs that are not covered. An example is a performance fee.
A final cost which should not be underestimated, but is not part of the current expenses, are the transaction costs a fund makes as a result of buying and selling of positions (such as equities) within the fund.
The higher the turnover rate of a portfolio, the higher the transaction costs of the fund. It is questionable at least whether this active trading actually yields something. What you know for sure is that the broker that executes the orders will make a lot of money. A high turnover rate can therefore limit the potential of a fund.
2. The fund is actively managed
To outperform the benchmark a mutual fund must significantly deviate from the benchmark (e.g. an index, like the S&P500). This is called active management.
An administrator can actively manage the fund in various ways, Schumacher knows. He can select investments outside of the benchmark, but also give positions in the benchmark a different weight than they have in the benchmark. In addition, a fund may differ by region, sector, currency, investment style, and market capitalization allocation. These are all different dimensions of active management. The degree of deviation is important.
When a fund remains too close to the benchmark, there are fewer opportunities to beat it. A fund that charges the costs of an actively managed fund, but actually is very similar to the benchmark will have great difficulty to realize added value in the long term.
3. The fund manager is solid
Ultimately, it is the fund manager who determines how the portfolio is constructed. The manager (or management team) plays a key role in the ultimate success of your fund. Among others, the experience of the manager and the relevance of that experience are extremely important.
Administrators who have a long track record are preferred. Investors who have proven themselves in different market cycles. Stability in the management team and support are also crucial factors.
Finally, it is important that a manager does what he is appointed for, namely to invest the capital of the shareholders in the fund as good as possible. An administrator must be able to concentrate on investigating and selecting investments for his portfolio and spend his time on creating a solid portfolio.
Peripheral matters, such as marketing talks and appearing at events should be kept to a minimum. If your fund manager is constantly manoeuvring in the spotlight, you should ask yourself how much time he is actually dealing with the management of the fund. A good fund with a strong track record sells itself, there’s no need for extensive marketing campaigns and certainly not by someone who should actually be putting his time and effort into the active management of the portfolio.