Tips for picking the perfect funds

One of the difficulties in selecting an individual fund manager is that performance data is based on the past and influenced by historical economic conditions.

Investment groups are often selective about the cut-off dates they use for headline figures, but you should look at the data from several angles.

How has the manager performed through both bull and bear markets? Did returns come from stock selection or sector allocation? Rolling returns can be useful in understanding the consistency of returns over time. 

The Sharpe Ratio is one way of measuring whether an investment is giving 'value for risk', and the level of return you're receiving for this level of volatility is worthwhile. The higher the number, the better.

You should also look for the other four 'P's of a good manager: philosophy, process, people and pay.

A firm or fund that lacks an ingrained philosophy of what it is trying to achieve will likely also lack the controls to ensure that investment decisions are implemented consistently.

Process refers to the steps a manager takes in their buying and selling decisions, and the group's risk management. You need to know whether the process will work in most investment climates.

Crucially, lack of a robust process makes a fund manager more likely to stray from their established style during difficult times, usually with adverse consequences.

Understanding the people behind the fund will include factors such as whether a star manager could leave a hole if they left the company.

Fund managers in small firms may need to devote time to running the business and client presentations.

On the other hand, chains of command in small firms tend to be short, and investment decisions can be taken more quickly. 

A smaller fund can also be advantageous for accessing opportunities, especially in the small company space where a large fund might not be able to take a meaningful position.

Also watch for situations where a fund manager is responsible for a number of different funds and favours some over others.

Regarding pay, the structure of the manager's performance incentive should align their interest with the investor's, and it is desirable for the manager to put their own money into the fund, known as having 'skin in the business'.

Morningstar suggests an amount greater than the manager's annual salary.

A useful indicator for future performance is Forsyth-OBSR Fund Ratings (, which aim to identify factors that will impact future performance, such as whether the investment style has been proven over time and the continuity of investment managers. A rating of AAA is the highest award.

This article was originally published in Money Observer - Moneywise's sister publication - in November 2010

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