Five warning signs to look for in a fund
1. Three years of underperformance
Alarm bells should ring if a fund has consistently underperformed in its sector over recent years.
2. Erratic performance
One year the fund makes 50%, the next year it's down by a similar amount. This might be down to market conditions, but you need to investigate.
3. High manager turnover
If the fund has been run by a number of different individuals over the past 10 years it suggests a lack of consistency in the management team.
4. The fund becoming too large
If a fund becomes very large it may become unwieldy and difficult for the manager to invest or switch holdings.
5. High gearing on investment trusts
If a trust is highly geared (has borrowed a lot) investors are more vulnerable to big losses if the market falls. It's safer to chose a trust with little or no gearing.
Investors who borrow money they use for investment and use the securities they buy as collateral for the loan are said to be “gearing up” the portfolio (in the US, gearing is referred to as “leveraging”) and widely used by investment trusts. The greater the gearing as a proportion of the overall portfolio, the greater the potential for profit or loss. If markets rise in value, the investor can pay back the loan and retain the profit but if markets fall, the investor may not be able to cover the borrowing and interest costs, and will make a loss. Also used to describe the ratio of a company’s borrowing in relation to its market capitalisation and the gearing ratio measures the extent to which a company is funded by debt. A company with high gearing is more vulnerable to downturns in the business cycle because the company must continue to service its debt regardless of how bad sales are.