Advice: How to Invest in Mutual Funds
Ten Tips for Active Fund Investment
Oct. 23, 2009
Recently MyPrivateBanking has published a report on the success of actively managed funds by private banks. This report has looked on some of the most common mutual funds (funds focusing on the regions of USA, Europe, Asia and funds with global coverage) of the 15 largest private banks and wealth managers worldwide. In short, this report confirms that managed funds of private banks underperform their benchmark indices in most cases. This is true even in case of emerging markets as our results show.
Many investors are wondering whether or not it makes sense to invest in active funds at all. Here are our top-10 guidelines for fund investment. The main take-away is: only when a fund manager can prove a long-term outstanding performance does it make sense to invest in an actively managed fund. Please note that our recommendations are meant for equity investments. But some of these rules also apply to other asset classes.
Invest only in funds with a proven, long-term over-performance
Focus mainly on investing in passive or index funds like ETFs for making up the core of your portfolio. In most cases these funds over-perform managed funds, in almost all cases they carry lower costs.
Invest only in a few selected cases in actively managed funds. Managed funds can over-perform their benchmark index in rare cases: The managed fund must have a long track record of superior performance based on clear and understandable investment strategies. It should serve as a warning sign in that we have rarely found funds with a 10-year track record in our analysis.
Watch the fund management and minimize the costs
Watch the fund management when investing in active funds. Usually an exceptional and extended superior track record is linked to an exceptional individual as fund manager. If that individual leaves the fund it is likely that the fund performance will change for the worse.
Always ask why a fund performs worse than the index. There are always reasons, like high internal costs, a good fund manager has left and was replaced with a bad one etc. Make sure you understand the reasons, and sell a fund if the cause of bad performance is not temporary.
Check the expenses of a fund. If the TER is high, a fund will have all the more difficulties to beat the benchmark.
Never pay any front or back load. Front or back load fees (one time charges when buying or selling a fund) go directly in the pockets of your bank. Avoid paying them twice.
Beware of funds with performance fees. More and more standard mutual funds use performance fees as is often seen in hedge funds. These fees are rarely beneficial to the investor and can cost a lot of performance, especially in bull markets.
Continuously check the quality and the share of funds in your portfolio
Ask your adviser to provide you with ranking tables for all funds in your portfolio on a regular basis. It is important to monitor the long-term performance of all funds in your portfolio. Make sure to look mainly at 5-year and 10-year performance (or even longer periods if available).
Regularly check the share of managed funds in your portfolio. As is recommended above, the core of your portfolio should be made up of passive or index products. In consequence you should make sure that the share of managed product stays below the limit you have discussed with your adviser.
Have a special eye on the black boxes of core/satellite products. Wealth managers tend to hide in “umbrella funds” often labelled as “core” or “satellite” managed products, thereby generating unnecessary extra costs.
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