A transparent and sound investment process Wealth Planner:
How should you choose your fund managers?
Making the right choices about your fund managers may not be the same as trying to pick a winner in a horse race but the difference between a great fund manager and a mediocre one can amount to several percentage points in terms of investment performance over a long period of time. Here are a few rules of thumb on what to look for in an investment manager:
A transparent and sound investment process
A strong, stable, commitment focused business
An efficient and effective back office support structure
A portfolio structure with appropriate risk-controls in place
A competitive and consistent performance track record
All of the above factors are all inter-related but one critical factor that is often forgotten by investors is that not all funds are the same in terms of investment objectives and risk profile, even though they may be classified in the same category. For example, according to Lipper, there are 22 Long Term Equity (LTF) funds to choose from with investment performance ranging from 23.51% for the best performing fund to 2.45% for the worst performer during the 12 months period ending May 2006. Admittedly, certain fund managers are truly better than others but to be fair, the various investment objectives of these funds also play a big part in the massive divergence in terms of investment performance. Some of these objectives include tracking the SET-50 Index, Top-25 Tilted Index, Growth stocks, Big Cap stocks, and Double-Selective strategy to non-listed stocks on the MAI market.
In order to help investors with their selection process, we have put together a simple chart above outlining where the various funds lie in terms of their relative risk profile and likely investment return.
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Essentially, all funds are subject to two main risks: Market Risk and Specific Risk.
Market Risk is the variability in a security's returns resulting from fluctuations in the aggregate market such as recessions, wars, structural changes in the economy, tax law changes, even changes in consumer preferences.
Specific Risk is the variability in a security's total returns not related to overall market variability such as unique business and financial risk as well as liquidity risk.
Virtually all securities, both stocks and bonds have two components of Specific and Market risks. By holding just one stock in your portfolio, your specific risk shall be quite high because you are betting everything on this one stock. However, as you start adding more stocks into your portfolio, the specific risk will decline substantially as different stocks will behave differently to external factors such as in a high energy prices environment, oil stocks will do well while airline stocks will perform less well.
However, you can only diversify away specific risk up to a certain limit, after which adding more stocks into your portfolio will not lead to any more reduction in overall portfolio risk because no matter what, market risk cannot be diversified away. If the stock market declines sharply, most stocks will be adversely affected, just like in May and June of this year; if on the other hand, the overall market rises strongly, most stocks will appreciate in value.
Therefore, as a general guideline in choosing mutual funds, index tracking funds i.e. SET-50 Index will in general, have lower risk than say actively managed funds i.e. funds that try to achieve higher return by investing in growth or value stocks or Big Cap and Small Cap stocks etc. One popular strategy is to put 50% of your portfolio in an index fund and the rest in actively managed funds with consistent track record.