Key checks to make when selecting an actively managed fund
We spend hours looking at various brands of watches or shoes to ensure we always buy the best of the best for ourselves. This same principle applies when shopping for a fund to invest in.
But sometimes, we don't necessarily know what we are looking for. This checklist will help in finding the right fund to invest in for yourself:
Checklist for fund selection
1. How long is the track record?
Obviously the longer, the better. However, from time to time an exceptionally talented fund manager with a long track record will set up his own shop. Some investors follow fund managers rather than funds, and this could be a good tip to bear in mind.
Such a fund would be well worth considering, especially as some of the bigger institutions might avoid investing until the fund is better established – giving you a good opportunity to be an early investor and have the chance to achieve higher returns from investment in a smaller fund .
2. Has the same fund manager been in place since inception?
Many asset managers will claim that funds are managed by more than 1 person (or a team), therefore, changes are irrelevant. Changes in the team from time to time are indeed perfectly acceptable, and sometimes not a bad idea! But constant change in the fund manager or managers is rarely a good sign.
3. What is the style of the fund and what is your risk appetite?
You will need the prospectus to check this out. If you always feel more comfortable with a ‘safe pair of hands’, and capital preservation is key for you, make sure that the fund is described as conservative, or sometimes, value. '
In general, an income-producing or dividend-focused fund would help with the capital preservation aspect. On the other hand, if you have no objections to a fund manager with highly volatile numbers, as long as he or she does extremely well over the long term, look for ‘aggressive’ or growth-oriented in the prospectus.
Some funds are held out as ‘balanced’, which means a combination of the 2 different styles just described. And there are of course many specialized funds, eg. gold funds, biotechnology funds, globally diversified funds, country funds, etc.
These types of funds will always be more volatile than a domestic fund because the diversification is limited, and there may also be a forex risk involved. Checking whether the fund is hedged is also a good idea.
4. What securities are actually held in the portfolio?
It makes sense to double check whether the securities held in the portfolio match with the style of fund. If the institution sponsoring the fund is very large and well-known, it is fairly unlikely that there is a mismatch.
For example, a fund described as conservative will typically hold a lot of blue-chips and quality yielding securities. A quick glance at the holdings to make sure will be enough.
5. What are the fees and expenses?
This is obviously a very important part of the due diligence process. Every fund is obliged to disclose its fees and expenses, and if you do not see them mentioned in detail in the prospectus, do not buy the fund! It is very important to know precisely what you are paying to the fund manager.
Check the fund's management fee, and whether there is a performance fee. While the range of fees and expenses can be huge, a good rule of thumb is to look for annual fees of less than 2%.
It is hard these days for the fund manager to justify charging more than that, because of the substantial drag on performance. If you cannot find a fund with reasonable charges, look at some US mutual funds – high fees on these funds are less common, due to fierce competition.
6. Does the fund offer daily liquidity?
The vast majority of actively managed funds offer daily liquidity. If the fund you are looking at lacks this, then be prepared to have your capital tied up for a while.
If the reason for offering reduced liquidity is that underlying assets are not ‘liquid’ enough, that should ring alarm bells.
7. How big is the fund?
Generally speaking, it is more challenging to successfully manage a very large fund compared to a smaller one. This is quite simply because statistically smaller stocks perform better than larger stocks over time, but a very large fund cannot easily invest in small stocks without negatively impacting the purchase or sell price. So unless the fund manager is truly exceptional (check that long term track record again!), a super-large sized fund will probably see lower returns.
Conclusion: The above checklist is by no means exhaustive, so always read the fund prospectus from cover to cover (yes, it may be boring, but extremely important!). Complete your due diligence, and all of the checklist questions about the fund (and any further questions you may have) should be answered.
Only then should you make a decision on whether you want to invest in that fund.