Selecting investments to match your asset allocation
Once the asset allocation stage is completed, we need to choose appropriate investments to reflect the various asset classes in the right proportions.
There are thousands of investment options to choose from, including Unit Trusts and OEICs, Investment Trusts, Exchange Traded Funds (ETFs) and Hedge Funds. All these options try to achieve different things. Understanding the reasons for their relative success in doing so helps us appreciate how they may perform in the future.
One of the first and biggest decisions to make is whether to take an ‘active’ or a ‘passive’ approach to investment management. An active approach is where the fund manager uses their skill to select stocks they think will perform better than average or better than the benchmark in a particular sector. The passive approach is where funds don’t try to beat the index; they just try to match it as closely as possible. Typically the cost of active funds is greater than passives.
Given the volatility around stock market investments, we believe that carefully selected active fund managers will typically be able to identify opportunities for ‘outperformance’ – doing better than average.
There are many ways of judging the performance of fund managers – their past performance is not necessarily a guide to what they might achieve in future. A better way to assess a manager’s performance is to understand how and why they achieved that performance – what process did they use? The first thing we will do when selecting a fund for a client’s portfolio is to filter them down to a select list by only looking at funds that:
1. Are domiciled in the UK
2. Have a fund size greater than £50m
3. Have had the same fund manager for at least 3 years
4. Have an OBSR rating of A or above
5. Fund Performance better than the sector average over 3 years
For the qualitative assessment of the fund, we have chosen OBSR as our preferred provider of these ratings because, while taking past performance of funds into account, the main focus of their assessment is on those factors which will affect a fund’s future performance. OBSR interviews many fund groups and fund managers, but they only award a quality rating to 250 funds across all the different sectors.
Their ratings range from A to AAA. So as not to restrict our choice too much, we consider for our clients’ portfolios any fund that has a rating of A or above. If the fund loses that rating in the future however, we would review its viability and we might decide to replace it.
Once we have filtered the initial fund list down to a select few, we then undertake quantitative analysis by looking at the metrics of the fund. The metrics give us an indication of how the manager has run the fund and whether their performance has been down to excessive risk taking or good stock selection.
The metrics that we look at are:
•Bear Beta, Bull Beta and Bull/Bear Ratio
•Annualised Volatility over 36 months
By combining all these selection criteria we can be confident of selecting suitable funds to build a robust portfolio.
In addition, buying any investment fund is a long-term decision so there has to be ongoing monitoring, measurement and evaluation; this is the final phase of the investment process.
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Investments and the income from them may fall as well as rise in value.
You may get back less than you invested.
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