What makes a good fund?
Ten factors to consider
5 minute read
We look at ten factors you should consider when choosing a fund.
The answer is performance. Of course it’s performance. If you are paying a fund manager to actively manage your investments, then you expect that fund to perform well. At the very least, to outperform a passive alternative.
So, maybe the question should be: what should I be looking for in a fund, in order for it to offer the best chances of delivering the performance I require in the future? Not quite such a catchy headline, but it is the million-dollar question. You can look at past performance as much as you want, but we all know it is not a reliable indicator of future performance. In that case, how can you assess whether a fund is going to outperform in the future? The truth is, you can’t. There is no magic formula or secret sauce. But, what you can do is understand how a fund is managed and make a formulated decision as to the chances of that fund performing well (or not) in the future.
At Barclays, we have developed a deeply considered and rigorously applied process for evaluating individual investment funds. To apply this process, we have assembled a significant team of experienced and dedicated due diligence professionals. Through our process and our people, we identify the investment managers who, in our view, are most likely to perform well in the future. The phrase ‘past performance is no guarantee of future results’ has become a cliché of disclosure language. For us, it is a core belief.
We have published an in-depth paper called: The Science and Art of Manager Selection, which explains how the team at Barclays assesses fund managers. Here, we take a quick look at ten factors (in no particular order) that make up what we believe makes a good fund.
There has to be a process. This is number one. There has to be a reason behind why the manager invests in every single one of the companies in the fund. There has to be a process as to how the manager and his/her team then monitors those companies. And of course, a process behind the decisions to sell them. Why is this so important? If the fund has a strong performance track record, as the result of adhering to a strict investment process, then it is our belief that if that process does not change (and the manager, or significant people in his/her team do not leave), then there is a chance that the strong performance could continue. It’s a bit like making a cake – if you follow the recipe word-for-word every single time you bake the same cake, there’s a strong likelihood that each cake will turn out the same.
2. Fund size
We believe that the size of a fund can have a critical impact on performance – with bigger not necessarily better. Put simply, managing a £10 billion fund is very different to managing a £10 million fund. There are additional issues with managing a large fund, with liquidity concerns being the most obvious. Whilst this is the norm, there are always a few exceptions to the rule, and we have found a select number of large funds exists which can continue to perform. It’s also worth bearing in mind that small funds are not always economical to run.
3. Staff turnover
Something that certainly isn’t published on the factsheet is how often key members of the team leave. We place great emphasis on this because significant turnover in staff can be disruptive. If we find such staff turnover, we make sure we understand why and what plans the business has in place to resolve this and retain staff.
4. Public vs. privately-owned structures
We look at a firm’s current and historical ownership structure. Firms can be 100% employee-owned or majority employee-owned; they can be public companies; or have parent ownership by a financial or strategic owner or an insurance company. All else held equal, we prefer firms where employee ownership is substantial and broadly distributed because we believe this structure limits turnover of key investment professionals and supports a long-term strategic perspective on the business.
5. Employee compensation
Basically, how the team gets paid! If you have a good team, you’ve got to make sure they stay, and part of that is to ensure they are being paid a market rate. But also, we like companies who have compensation schemes based on rolling multi-year performance in line with their investment time horizon, often with their annual bonus tied up in the fund or company stock. We believe this is the most appropriate method of bonus compensation. Compensation structure is a key determinant to employee turnover, especially in competitive markets like New York, London, Hong Kong, and Singapore.
6. Learning from their mistakes
Detecting investment talent is more art than science. It’s not about being a good presenter or having reams of qualifications. It’s about many things. Many things that can’t always be quantifiably measured. One of these is learning from your mistakes. It’s about fund managers admitting when they got something wrong and having the humility to admit their mistakes and learn from them. A successful fund manager only needs to get 51% of their investment decisions right. A talented fund manager learns from the other 49% and strives to improve their investing process.
7. A named fund manager
A fundamental part of our analysis is understanding the decision-making process, and how securities are bought or sold in the portfolio. We want to identify who is making those decisions, and make sure that the process has been in place consistently throughout the period of the track record. As a result, we generally prefer a structure where the fund manager makes the decisions, as opposed to a consensus team model. This places a direct onus of responsibility on key individuals.
8. Sell discipline
We hear a lot about when to buy, but when do fund managers sell? We invest in funds for the long term – we then rely on the fund managers to buy and sell shares within that fund. Knowing when to sell can be more difficult than buying, so we need to ensure there is a rigorous process in place that has been successfully adhered to.
9. Performance in up and down markets
In our search for funds that have the potential to deliver long-term performance, we analyse how they perform during different types of markets. It’s fascinating how each different fund manager has a different ‘style’ of investing. Some do very well when markets are rising, some do well when markets are falling. We analyse every different type of market (including times when markets are flat), to understand clearly what to expect from each manager’s investment style. We can then hold a number of different funds together, to deliver a smoother and more consistent level of performance.
Much has been reported in the press about the threats of cybercrime. There have been many examples of disruption, including the WannaCry malware that targeted the NHS Windows system in 2017, and yet, the level of cyber protection varies from one manager to another. There is no doubt that this is a significant concern we all face in our daily lives as individuals, from how we use digital media to how we invest and whom we invest with. We conduct significant research into understanding the threats and how they can be combated, and discuss and afford our experience with managers.
The word ‘process’ has been mentioned numerous times here. It’s extremely important. Each of these ten examples is just one part of a fund manager’s process that we scrutinise. Without a process that covers each of these areas, it’s impossible to understand if skill is responsible for investment performance, or if it is just luck.
It is also worth noting that none of this information is available on the fund factsheets. The only way to understand how a fund works is to conduct thorough and rigorous research, and having access to the fund manager and the rest of the team is a key determinant that Barclays is privileged to have.
What makes a good fund is not looking at past performance. What makes a good fund is linking a successful investment process to that performance.
Things to consider
The value of investments can fall as well as rise. You may get back less than what you originally invested.
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