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Managed Funds
How to pick a champion managed fund
Fiona Harris - July 21, 2008
 They may be the simplest way to invest, but with over 10,000 managed funds to choose from, trying to select a champion fund, is a daunting task.
Even the experts say so.
“It is so hard,” says Michael Clancy, general manager of MLC’s Investment Management Division. “The hit rate is less than 50/50 so my honest answer is its best not to try.”
A big reason why the challenge is so great is because the two pieces of information most readily available to investors, namely a fund’s brand and performance history, are flawed.
“How much you spend on advertising has nothing to do with whether your hire or keep great investment people with sensible process who achieve great results,” says Clancy.
And as for past performance, the disclaimer that fund managers print in their Product Disclosure Statements (PDS) that says ‘past performance is no guarantee of future performance’, is actually true.
So what’s an investor to do?
1. Research
Independent research from research houses such as Morningstar or Standard and Poor’s is your best friend when sourcing reliable information.
Both these research houses have a five-star rating process helping you decide what fund will best suit your investment needs. You can also search funds according to fees, returns, category (such as Australian shares or international shares), and even risk relative to its category.
They also provide a fast track alternative to a bulky PDS.
“Investors typically read the first three pages,” says Ron Hodge, managing director of online business InvestSMART. “But you need to go to the back, to the additional information which always has the unsavoury things like interested third party transactions.”
Issued by a fund manager, a PDS contains information on fund features, fees, the benefits and risks of investing as well as any commissions.
Other great sources of information include fund manager websites, fund manager newsletters and communication material from the independent research houses. Clearly, by the time you get to looking at all of this, you’ve already significantly narrowed down your choices.
2. Understand a fund’s total fees
You should be able to identify all the fees relating to the product you are researching – is there a platform fee, what is the Management Expense Ratio (MER), what are the entry or exit fees and is there ongoing trail commissions?
While fees such as entry and exit fees can be avoided through services such as 2020 DIRECTINVEST and InvestSMART, MERs cannot and their impact should not be discounted.
“There have been a number of studies now that show the Management Expense Ratio has a big impact on the outperformance of any manager,” says Chris Douglas, senior research analyst, Morningstar Research.
“Some funds MERs are well over 2% but if you’re looking at an Aussie equities fund, and if you’ve got over $50k to invest, you should expect to pay 1% per annum.”
3. Boutique funds are not always champion funds
“A boutique is defined as a principal who has their own skin in the game,” says Hodge. “And typically we would invest with someone who has also got something to lose.”
However Douglas says large institutional investment groups such as BT are changing the way they remunerate their fund managers to establish an “equity tie-in” over a 3-5 year period rather than simply paying them cash bonuses.
Remuneration aside, boutiques have other attractive features notably their nimbleness when buying smaller stocks and selling out of losing stocks and the tendency for top performing institutional fund managers to launch their own boutique funds.
But boutique does not always mean champion.
“Things like long-term earnings and star-ratings are more important than if it’s a boutique,” says Douglas.
4. Market conditions dictate what’s in style
There are two main types of investment style. Some fund managers choose high dividend stocks and are known as value managers, while others choose low dividend stocks, and these are known as growth managers and between these two extremes there are a few variations.
van Eyk research’s director Mark Thomas says most investors do not realise a fund’s performance largely depends on market conditions, which of course change over time.
“Most people are turning to value stocks because most people are going to blue chip stocks with higher dividends such as financials,” says Hodge.
However Thomas warns investors to not fall into the style trap.
“Mid last year, the theme was private equity funds. But the environment suited them. There was good liquidity in the market and there was risk taking. But with the sub-prime collapse, there has been a shift in the environment.” The best way around the style dilemma is to combine a variety of managed funds including value, growth and even style neutral managers.
5. Know the tax implications of a fund
Even if you’re not an investor on the highest marginal rate of tax, you should always consider tax, as just like fees, the capital gains and losses incurred by a managed fund, reduce your profitability.
Some funds such as imputation funds focus on generating franking dividends to help reduce an investor’s tax liability.
However as Hodge says, the investment should be an investors overriding concern because most people are happy to pay tax as long as they’re making money.
More articles from this edition of CompareShares:
Share tips: Broker Stock Recommendations 21 July – 6 to BUY, 6 to SELL and 6 to HOLD
Managed funds: How to pick a champion managed fund
Stock picks: Stock of the week – Mermaid Marine Australia
Expert panel: Why do futures prices converge on spot prices during the delivery month?
Superannuation: SMSFs – Negative returns not required
US markets: The worst is yet to come
Economy: Export rise buffets Aussie economy
Takeover: Eagle Boys devours Pizza Haven
Finance: Monitoring of super funds stepped up
US Banking: Treasury chief says US banking is sound
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