Choosing Active

What makes you think you are so clever?

Any book of investment advice lists a number of things you must check out before investing in an actively-managed fund. Here's one such list:

  • Balance with the rest of your portfolio
  • Avoid poor historical performance
  • Track the record of the fund manager
  • Look for consistency of performance
  • Analyse the fees
  • Look for a manager who invests in his own fund
  • Check the risk level
  • Check the manager's investment constraints
  • Look at the fund size
  • Check that the firm behind the fund is stable

Now this is good advice. It's also a process that we would find it hard enough to complete for ourselves. You, gentle readers, who have found something better to do with your lives than become investment anoraks, would find it quite impossible.

Why not pick one at random?

The trouble is that the average fund does not deliver.

Research has consistently shown that actively-managed funds fail to beat their benchmarks, on average. 'Actively-managed' means that the fund aims to apply superior skills to improve returns. Usually, the level of management fees reflects the high skill supposedly applied.

But what happens is that costs exceed any superior returns obtained. In other words, excess trading gains go into the pockets of the managers and not into yours. Indeed, in a fixed-sum game that must always be so.

So you would be better off throwing darts at a stock list instead of picking a fund at random. Or, if you feel you need more diversification, buying a tracker.

How do you pick one?

So here's some better advice:

  • Talk to a proper adviser before you do anything.
  • Understand the importance of costs. Only buy funds that clearly state their Ongoing Charges Figure (OCF), not just their management fees. (For a general fund this OCF should be less than 0.50% with zero initial charges and zero exit fees. For a simple index tracker or ETF it should be less than 0.1% ). If a fund is ambiguous about its costs, what else is it trying to hide?
  • Ignore historical performance unless it has been processed by an independent analyst. Poor historical performance indicates a dog. Good historical performance proves nothing. See Pick On Performance?
  • If you take costs seriously you will only be buying trackers or other low-cost diversified funds
  • Funds can always put their charges up (did you realise that?). Look at the Fund's long-term reputation to reduce the risk of that happening to you.
  • Before buying a fund at all, consider whether you are getting enough extra diversification to compensate for the lower return you will achieve (because of costs) compared to direct investment in equities. Reconsider your attitude to risk.
  • Don't buy a fund with persuasive advertising. You are paying for all that clever marketing. If you doubt this, look at some of the pages in "Choices". Particularly Hype.