How to choose a return focused fund

23 June 2016

Patrick Norwood, Insight Analyst (Funds)

Return focused funds aim for capital growth or a mixture of capital and income growth, usually over the medium to long term. Sometimes they will target a stated level of return, such as ‘CPI +4% net of fees’.

When we consider return focused funds we divide the ‘universe’ firstly by the four Investment Association (IA) ‘Mixed Asset’ sectors (which differ by equity content and therefore expected risk and return) and then by whether the fund is multi-asset or multi-manager, giving eight different sub-universes. This ensures that we are comparing like with like when we rate these funds.

In the case of a multi-asset fund, one fund management firm invests directly across the different asset classes; whereas with a multi-manager fund the fund manager selects a different fund or manager for each different asset class. The rationale for multi-manager investing is that no one manager can be the best across every single asset class and instead one should seek out a specialist manager for each different area. The disadvantage of this approach is that by employing other managers an extra layer of fees will be introduced, making multi-managers more expensive than multi-asset funds on average.

Within multi-manager there is the option of (mainly) fettered or unfettered funds.  With fettered, the underlying funds can only be chosen from elsewhere within the fund management organisation while in the case of unfettered they can be chosen from any fund management firm. The big advantage with the latter is that the opportunity set is much larger. With fettered funds, however, costs will usually be lower and the multi-manager will have constant and more detailed access to the underlying fund managers. Also, fewer managers to concentrate on allows for greater focus.

Return focused funds will also be predominantly ‘active’, ‘passive’ or a blend of the two. With active management, there is the chance to outperform the respective index, but also the risk of underperforming it. Passive funds, meanwhile, simply track the index and will normally be much less expensive.

The other big decision regarding return focused funds is whether to select one which invests in just ‘traditional’ asset classes or one that invests in traditional and ‘alternative’ assets. The latter type offer greater potential for higher returns and diversification; however, they can also be more risky and expensive and less transparent.

Once the above choices have been decided upon, then many of the general fund selection factors will apply: strength of underlying business, quality of the fund managers, investment process, costs and performance, preferably risk adjusted.

At Defaqto, when calculating our Diamond Ratings for return focused funds we use the Sharpe and Calmar ratios to measure risk adjusted performance, with the latter focusing on downside risk. Other factors we look at include charges, manager tenure, fund size and number of distribution partners.

Share this