How to choose a fund manager

The job of a good adviser is to devise a strategy and pick a combination of investments to out-perform the market and continue to grow clients' portfolios in a positive direction with ongoing management.

There is now over $1 trillion in Australian managed funds (as at March Qrt 2007: source ABS) including superannuation and life company funds. There are over 15,000 different products on the market and funds management is one of the fastest growing industries in Australia. There is not likely to be any let-up with assets under management expected to double in 6 years to $2 trillion and triple in the next decade. In fact Australia's funds management industry is the fourth largest in the world behind USA, France and Luxembourg.

Like all investments, the two most important factors overall in choosing managed funds are risk and return. Everybody wants a return on their money and nobody wants to lose it. Even the most aggressive investors on paper will still moan if their fund hits negative territory.

So how do we choose the right funds for clients and make sure we are on top of our selections?

Research

Although not the be-all-and-end-all of investments decisions, research houses offer the fist step and probably the last step in analyzing managed funds.

All researchers look at the funds with a set of criteria in mind. They measure the performance relative to the market the fund is investing in (the market index) as each fund manager is constrained by the market in which they invest. They all want to add value by outperforming their index. How they do this is up to each individual fund manager and it is this that sets them apart from other fund managers. The researchers give the fewest stars to the fund manager with the poorest performance and the highest risk rating. Combine high risk and poor performance with high fees and a fund manager in this category has little chance of being selected for anyone's preferred list. As advisers we utilize the services of a number of research houses.

Approach to the markets and economy

As advisers we are not restricted to specific markets or countries, as some fund mangers are, so we can make choices on where to invest depending on where the opportunities lie. For example a fund manager may invest in the Japanese commercial property market which may have a poor long term outlook. The fund manager cannot decide to invest somewhere else because the commercial property market has a poor outlook; he is mandated to invest in this market sector. It's possible that the manager may have a 4 star rating and outperform other managers in the sector by 10% but if the rest achieve -8% and he 2% that doesn't mean we would invest in the fund or the sector. The best this fund manager may be able to do is to sell and go into cash to take advantage of a buying opportunity in property at a later date. Put simply, the manager is a property manager in a terrible market; but it certainly won't be where we put clients' money.

Looking up or looking down

So to start our selection of managed funds we have to look globally to where the markets are performing and ask some basic questions. Is the performance short or long term? Is it sustainable? Is the economy stable? Then we start to look deeper into each country to see which sectors are performing: is it mining or industrials, etc? Once we establish this, we then look at individual funds and fund managers who are performing in this area and who have a track record of strong performance. Needless to say this is called the 'top down approach'.
The other approach is the 'bottom up' method which looks at specific stocks and works up through the levels rather than down.

Both methods will identify certain sectors and economies which are performing. Remember there is always a property market performing somewhere in the world. The trick is to get in first, not at the end of the cycle.

Picking the right fund manager for the job

Without doubt some fund managers have a talent for picking the market and therefore the returns of the fund. Some US fund managers have been able to achieve over 20% growth for their funds for years. So if a fund manager leaves an institution it may have an affect on the fund's performance.

We are always looking to see if the funds have a change of management. There have been many Australian examples of fund managers leaving certain institutions and affecting the fund's performance; BT, Colonial First State and AMP to name a few. So when a fund manager leaves his institution warning bells sound and we review the fund. The same applies if a new manager comes on the scene. Why is he there and what value will he add? This does not mean we will dump the fund simple because of a management change, which may cause additional costs and have capital gain implications. It just means the fund is in the 'we are watching' basket.

Buying more business

Often institutions will expand by taking over smaller firms in their quest for growth and funds under management. This can cause staff disruption and affect fund performance, especially if they are cutting costs and trying to influence how the funds are managed by starting flavour of the month funds.

Management styles

Each fund manager has a style or disciple to which he adheres. You may have heard of value-style mangers or growth-style managers. Each is different and can suit different cycles of the market, but in the end we want consistency we don't want a fund to do nothing for a few years and then perform out of the box when the market changes to suit its investment style. It shows bad management from managers if they can only get it right in certain conditions and can't adjust to cycles.

The Goldilocks fund approach

You can't be too big or too small. You must be just right. If a fund is too big it takes too long to react to market changes. If it is too small it may not be taken seriously. It is harder for large top performing funds to keep outperforming the market. They sometimes become victims of their own successes as they are no longer nimble and able to adjust and be flexible. Even the research houses may downgrade funds just because they become too big.

Closed funds

If a fund is closed to new investors it is time to re-evaluate. Has the fund closed because it is the right size or has the manager stopped new investment because the market has run its course and room for further returns is limited? This is called mothballing and may happen for a number of reasons. Is the opportunity still there? Remember the Tech crash? Some funds were created to take advantage of this bubble and are still sitting on losses now. Many of these funds should be closed and with good reason. Unfortunately many are still open and people are still sitting in them being charged fees with little possibility of recovering. This is where a good adviser is worth their weight in gold in making sure the client cuts his or her losses and does not fall in love with a fund especially if the fund manager has ceased caring (a serious trap for a young player).

Time to say goodbye

As I said originally, performance is paramount so when we look at fund returns we look at consistency. This means tracking all funds over a 12 month and 2, 3 and 5 year timeframe. If for any reason the manager does not perform over these periods it is time to review and in some cases say goodbye. Investment is never set and forget.

How we choose fund managers for clients