Selecting an investment fund in can feel a bit overwhelming with thousands to choose from and many ways to measure and compare them. Personally, I start with a few key considerations to narrow down the vast number of funds available into a reasonable set of choices.
Begin with strategy
A good investment is one that aligns with your goals, timeline and risk tolerance. Is this investment part of your long term plan to secure your future or are you looking for quick returns? If your goals are short term, i.e. five years or less, you may want to take a lower risk approach to avoid short term volatility. Going for a low risk approach also means trading off the reduced risk of loss with more moderate gains.If you’re looking to the long term, you can have an investment strategy that might be subject to short term volatility but fundamentally backs predictable trends such as those based on backing solid well-managed companies, new technology, emerging markets or population growth. This is how Warren Buffett grew his and his investors’ wealth through Berkshire Hathaway.
While it is often a good idea to look at past performance when trying to predict future performance, with funds, past gains can’t guarantee there won’t be flat or negative results in coming years. Looking at cumulative performance against the fund’s benchmark or sector can help determine its success but looking at it alone can be misleading. A fund manager can have one very lucky year that makes cumulative performance look good even over 10 years. Indeed contrarian funds have many poor years but the stratregy is justified when the market turns in their favour as is a strategy also pursued by some hedge funds albeit with much shorter term bets. If possible, I always look at discrete annual performance as well to see how well a fund did in each individual calendar year.
When looking at sector performance figures it is important to be aware that even if the sector looks promising, these figures are often distorted by survivorship bias, concealing the fact that many funds shut down each year due to poor returns. Last year 784 hedge funds went out of business compared to the 735 that launched. Sector based investment strategies can however be highly successful when looking for long term performance since market research can be used to underpin the sector despite any short term fluctuations. It is the short term pursuit of quick wins that has caused so many hedge funds to come unstuck.
Global hedge fund launches and liquidations 2010 – 2017
Source: Hedge Fund Research Inc
Look at the Manager
Check the fund’s factsheet to see how long the fund’s manager has been there. Highly skilled managers with long tenures are more likely to outperform unproven newcommers where past performance is a good indicator of their investment success. It also allows you to see how the manager has performed in market downturns. However longevity does not provide a guarantee. Last year several prominent hedge funds closed down including Hugh Hendry’s Eclectica Asset Management which ran for 15 years and at its peak had $1.3 billion in assets under management. Neil Chriss’ Hutchin Hill Capital and Erich Mindich’s Eton Park Capital also closed last year.
I also look for funds where the manager has a substantial portion of their personal net worth invested in the fund. Nothing will motivate the manager’s performance more than their own bottom line.
Pay attention to the fees
Running an investment fund takes money. Legal fees, office rent and electricity all need to be paid for before money can be invested. The percentage of assets that go toward these things is known as the expense ratio where I look for funds with the lowest possible but am mindful of how much they spend on research versus other costs. It’s also important to pay attention to the Ongoing Charges Figure. The expense ratio leaves out initial sales charges, performance fees and transaction costs. For private investors all these fees can prove fatal. With the introduction of Mifid II in January this year investment firms are required to inform their clients of all the expected costs to the client before providing any services. Therefore unlike return, fees should be firmly established and known in advance.
I hope this article proves helpful when selecting your next investment fund but I ask that you please add your own considerations as to what you’re looking for, this is just my own starter-for-ten. It is also vital to remember that no matter how carefully you select an investment fund, you’re not guaranteed a gain and you could lose your investment.
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