Investing Basics: Stronger Together – Selecting an Investment Fund

You’ve joined the gym, plan to have a crack at ‘Stoptober’ and now it’s time to deliver on that note to self to take control of your financial affairs. Christian Leeming looks at some of the options available to those considering investment funds.

 
An important first step for the DIY investor is to construct your own financial plan.

Before you start selecting funds, that means deciding just what your investment goals are, deciding on your investment horizon, and perhaps most importantly making a judgement on level of risk are you able to accept.

As rule of thumb, the further away your objective, whether that be retirement, buying a home or paying for children’s university, the more risk you can accept in your portfolio.

After all, you have longer to smooth out returns and make up for losses. But it’s always important you can sleep at night – never take on more risk than you are comfortable with.

However wedded you are to self-directed investing, this may be the point at which you consider taking some professional advice. Alternatively, you could try one of the online platforms that will assess your risk tolerance and suggest suitable product types.

Allocating different asset types to help meet your objectives and risk and diversifying your portfolio are key tasks for DIY Investors. Asset classes behave differently as conditions change.

By building a diversified portfolio you can protect against market volatility and ensure you benefit from growth stories wherever they occur.

Consequently, a well constructed portfolio will offer exposure to different shares, bonds, markets and sectors.

‘funds offer a solution since each one represents a diversified portfolio in themselves’

That can sometimes be difficult for investors to achieve – especially when they are starting out and beginning to build that portfolio.

Fortunately funds offer a solution since each one represents a diversified portfolio in themselves.

If you decide that investment funds are going to form at least part of your portfolio construction, there’s a wide choice available that can help you to achieve your goals.

Types of Investment Funds

Funds are sometimes known as ‘collectives’ which pool funds to invest in a range of underlying assets.

The wide choice available ranges from funds actively managed by professionals, backed up by teams of analysts, to those that simply track an index or market.

Trackers may follow popular markets such as the FTSE 100 or Dow, emerging markets and even commodities, currency and property.

Look out for the different types of active or passive management available. These might be

 
 
Active Management where the fund manager builds and adjusts a portfolio in order to meet a fund’s stated objectives.

Absolute Return which tend not to be asset class restricted but aim to achieve positive returns irrespective of market conditions.

Multi-Asset which offer exposure to different asset classes.

Fund of Funds which invest in other collective funds in order to benefit from the best investment management out there.

Trackers which passively match the performance of a given market or index.

While these are the objectives of the funds, you will find a variety of structures from Unit Trusts and OEICS to (quoted) Investment Companies, to index tracking Exchange Traded Funds.
 

Pick a Fund or Pick a Fund Manager?

One of the great things about the internet is that it is relatively easy to compare the past performance of different funds and the past performance of fund managers.

It’s why many fund managers become ‘stars’ to their companies and investors.

As Head of UK Equities at Invesco Perpetual, Neil Woodford became one of the most notable. He managed almost £25 billion of assets and was afforded City rock-star status due to the market-beating returns he achieved.

When he went it alone many investors followed him in the expectation of equally stellar returns; unfortunately, as is well documented elsewhere on this site, it did not end well as the portfolio of increasingly illiquid investments was first gated, and then sold off in a fire sale, leaving many facing heavy losses.

It is vitally important to review manager and fund performance against their benchmark.

You should do this before you invest and continue to monitor once you hold the fund. Fortunately, there are companies such as Morningstar and Financial Express who use historic data to rank funds and DIY investors can use these.

When it comes to the most abundant funds – Unit Trusts and OEICS – many DIY platforms have fund selector tools to allow you to screen the thousands of products that are available and most will allow you to avoid the Initial Charge of up to 5% you could incur by going direct to the fund manager.

‘the new ‘clean’ class can sometimes be ‘unbundled’ (there’s also ‘super-clean’) and those with higher management fees ‘inclusive’’

Some will offer a range of ‘Best Buy’ or ‘Selected’ funds that may come with specially negotiated terms and you will have the option to invest a lump sum or set up a regular investment.

Make sure that you take full advantage of ‘NISA’ accounts that allow you to invest up to £20,000 p.a. (2022/23) free from Capital Gains Tax.
 

‘Clean Funds’

 Most Unit Trusts and OEICs will require a minimum investment – typically £500 to £1,000 – and there are often two versions of each fund- an accumulation class (acc) which rolls all dividend income back into the fund to boost growth, or an income class (inc) which pays out dividends to those who wish to have them as income.

Historically funds levied a 1.5% Annual Management Charge (AMC) which paid for the running of the fund and returned half of that to financial advisers and platforms that sold the fund.

However, the government’s Retail Distribution Review (RDR) in December 2012 prohibited these payments for new investments and new ‘clean’ funds were introduced, which typically charge 0.75% to 1% and pay no commission back to advisers or platforms.

‘It’s why many fund managers become ‘stars’ to their companies and investors’

The arrival of so called ‘clean funds’ has meant a baffling array of types of the same funds with little consistency in terms of their naming convention or charging structure.

As such, the new ‘clean’ class can sometimes be ‘unbundled’ (there’s also ‘super-clean’) and those with higher management fees ‘inclusive’; AMC is a drag on your investment, so it is important to understand the charging structure of the funds you select.

To make an apples-and-apples comparison look at the Total Expense Ratio (TER) of the fund to see the total cost of ownership or its replacement, ‘Ongoing Charges’.

That’s it for now – you’re on your way to being a DIY investor and taking control of your financial future; stick with it and all of those financial goals can be within your grasp.