Selecting Investment Funds – a visit to the bookmakers

Whether it is within an investment ISA or private pension, you will often be given a long and rather daunting list of investment funds to choose from. The product provider will produce glossy material containing fund performance statistics, star ratings from various external agencies and descriptions of the fund manager’s style and approach.

In addition, the weekend financial press will be full of advertisements from investments fund managers promoting their latest ‘star manager’ who has ‘beaten the market’ by a huge margin in the recent past.

In this age of immediate and detailed information, one would think that the selection of investments funds would be relatively easy. Think again.

‘Winners’ do not tend to repeat

The job of an ‘active’ investment fund manager is to select individuals stocks (i.e. investments in individual companies) in order to beat the investment return from the broader market in which they are investing. For example, a UK fund manager may be given the job of outperforming the FTSE All Share Index.

There is a huge weight of evidence showing that the majority of active fund managers do not beat the market over any time period you care to choose, in particular over longer periods. In addition, the ‘winners’ do not tend to repeat their outperformance. Countless studies from academics and financial institutions such as Vanguard have proved this point.

It is important to stress that, in any given year, there will be fund managers that do beat the market but the point is that you need to know in advance who the ‘winners’ are going to be. In over 20 years of working in the financial services industry, I have yet to see a reliable, repeatable method of predicting the winning active fund managers in advance.

The myth of the ‘star fund manager’

The active fund management industry is based on clever marketing that is of little or no use to an ordinary investor (or their advisers for that matter).

A typical scenario is where a young fund manager produces excellent performance and beats the market over, say, a three year period. His employer then throws a huge amount of money into promoting the investment fund in the financial press. Money flows into the fund and, eventually, the fund manager runs out of luck. The fund manager disappears into obscurity, investors become disenchanted and the fund provider turns their attention to the next fund manager that they choose to promote.

Some people would point to established fund managers with long term track records such as Neil Woodford at Invesco Perpetual. However, I challenge you to create a fully diversified investment portfolio containing 10 or so different types of assets, comprising of the likes of Neil Woodford. There are simply not enough of these managers out there and trying to select outperforming active managers is no different to betting on the horses. You can construct as detailed a narrative as you like about why a certain manager has been selected but it is still a gamble.

What is the alternative?

Instead of investing as though you are at a race track, we advocate low cost, reliable, investment vehicles where the aim is to provide market rates of return. This takes the guesswork out of investing.

We can prove that the most important investment decision is how your money is spread between various ‘asset classes’ (e.g. equities, bonds, property). The aim of our investment portfolios is to provide the market rate of return for each of the asset classes we invest in.

By doing this, we can prove that you will outperform the vast majority of investors. It is a complete myth that investing has to involve selecting star fund managers.