What should investors consider when choosing an investment fund?

Jacqueline Lockie, AIC Head of Training

Over a third of investors (38%) believe that performance is the single most important consideration when choosing a fund, according to research from the AIC using survey data from Morningstar. The second most influential factor when choosing a fund is the manager, with nearly a quarter of investors (24%) believing this to be the most important issue, whereas the third highest consideration for investors (16%) was the portfolio composition. Charges perhaps surprisingly ranked only the fourth most important feature when considering a fund.

Interestingly, investors did not consider other features such as the level of discount or gearing exposure as the most important areas for consideration (each ranked as most important by just only 1% of investors) when choosing a fund.  The least important reasons according to investors were media coverage and communication and marketing.

Which features should be considered most significant when choosing where to put your money?

Portfolio composition

Portfolio composition is by far the most important of all the options. Research shows us that the way to control variance in returns is to identify and control the asset allocation, or the range and types of investments bought inside a portfolio, as this is what drives the returns achieved. It’s all about risk. For example, you may be interested in a small cap fund as it has the best performance track record, but this would be more risky than perhaps a blended fund with a mix of asset classes. This small cap fund might be wholly inappropriate for you from a risk point of view, and you might experience larger fluctuations in value than you are used to.

Charges

Second most important are the charges. All charges on a fund drag back its performance and reduce it. If a fund increased by 7% in the last year, but the total charges were 1.5%, the returns to the investor would be only 5.5%. The bigger the charge, the harder the fund has to work to stand still. We need to remember, however, that it’s not all about pressing for low charges and high performance. If only! Charges have to reflect the amount of research and specialist expertise needed by those employed to select the individual investments. Some funds, such as private equity funds, are very manpower heavy, so the charges on those types of funds are likely to be higher than more mainstream funds. The main point to remember is that investors need to establish what the ongoing charge is and then look at the cost for buying and selling and any associated administration charges.

Geographical weightings

If you are looking at either country specific or sector specific funds, then geographical weightings should be a consideration. For example, if you were interested in a UK fund, it would be important to ensure that it included a good spread of all the sorts of industries and sectors that represent the UK. This would mean that the returns fairly reflected the UK and you wouldn’t miss out on a high returning sector. You don’t want to miss out on any positive performance, but as you wouldn’t know which areas were more or less promising, you need to hold some of everything. If you were looking at a truly global fund however, this would already have the weightings built in to ensure a decent spread across the world economy.

It’s interesting to see the contrast between what private investors and I, as an ex-adviser, consider most important. Private investors still put past performance first, even though the regulator tells us this is not a guide to future performance, while I believe portfolio composition to be the most important consideration. Investors should always do their research when considering an investment fund choice.

Results of the survey

Jacqueline is a Fellow of the Institute of Financial Planning and holder of the Certified Financial Planner licence, for which she was one of the first examiners in the UK.  She also holds the Investment Management Certificate and the Professional Investment Certificate.