1. DO YOU KNOW WHAT YOU ARE LOOKING FOR?

When selecting a fund manager you should have a clear understanding of their role in your investment portfolio. Ask yourself these sorts of questions.

Do you want a fund manager who will give you ongoing exposure to a specific asset? Or do you want them to predict when a market will rise and fall, and buy and sell assets accordingly (timing the market)?

Are you comfortable investing for the long-term, or do you need your money back in one or two years’ time?

Would you prefer your fund manager to have the ability to protect your capital during times of market stress?

Developing clearly defined goals for your portfolio is a very important first step.

2. DOES THE FUND MANAGER INVEST IN THEIR OWN FUND?

If the fund manager invests in their own fund, then their interests will be more closely aligned to yours. With larger, more institutional funds, fund managers may not be required to invest in the funds they manage. If a manager is not willing to have their own ‘skin in the game’, consider why you should support them. It’s like a Holden salesman driving a Ford.

3. IS BIGGER BETTER?

Not necessarily. Research shows that the bigger a fund gets, the narrower the gap between the fund’s performance and that of its index. As the size of the fund increases, the more its managers may be inclined to buy stocks in larger companies, ignoring stocks in smaller and more nimble businesses that might have performed well in the past.

Alternatively, larger fund managers may also choose to invest in a higher number of smaller companies, leading to more diversification. This is not always a good thing, as the more diversified a fund becomes, the more likely it can end up like a ‘closet index fund.’ This means the fund’s performance is similar to a cheaper, passive index fund, but still has higher management fees. So you pay for active management, but you get passive performance.

Tip 7 (over the page) explains more about active and passive fund management.

4. DOES THE FUND HAVE EXTERNAL INDEPENDENT DIRECTORS?

The role of an independent director is to ensure that a fund management company has a corporate governance framework in place. As part of this governance process, good, independent directors will ensure that fund managers follow the company’s agreed investment mandate.

5. WHAT IS A FAIR FEE?

The type of fund you invest in, the service you receive and the outcome you get should determine the level of fee you pay. For example, you would expect lower fees on a cash fund and higher fees on an equity fund.

Some managers charge performance fees. If they do, it is essential to check whether the fund has a ‘high-water’ mark. An analogy to a high-water mark is high tide at the beach: a fund manager only gets paid a performance fee if the fund unit price (tide) exceeds its previous high.

Performance bonuses can sometimes be tricky to understand. If you’re not sure how they’re calculated, don’t be shy about approaching the manager directly and asking.

If a fund manager with a fair fee structure is paying themself a large performance fee, this may not be a bad thing — it should mean you’ve had a stellar outperformance.

6. ARE FUND MANAGERS BETTER THAN DIRECT STOCK PICKS?

When picking stocks directly, you need to do all of the research and construct your portfolio yourself. You’ll also need to monitor and review each of the stocks closely, and decide when to buy and sell, and at what price. The job of your fund manager is to relieve you of this burden and stress.

If you’re in a higher tax bracket then you could end up paying more tax, as Portfolio Investment Entities (PIEs) enjoy the advantage of a capped maximum tax rate of
28 per cent.

7. SHOULD YOU USE PASSIVE OR ACTIVE FUND MANAGERS?

This is a hotly debated topic in the investment world, with staunch advocates on both sides.

Active fund managers will try to outperform the market, while managers of passive funds will mirror the performance of the market.

Active managers will set buy-and-sell limits for each of the stocks they hold, which means they can purchase stocks at levels they consider favourable, and exit when they view stocks as fully priced. Active managers are also able to offer protection to fund values in falling or volatile markets.

8. HOW DO YOU COMPARE FUND MANAGERS?

In New Zealand, you can access independent research (for a fee) on most funds from Australia-based Morningstar or Lonsec. Both research institutes monitor a large number of New Zealand funds, and they produce performance measures, as well as rating funds and providing commentary.

If you’re looking to select your own fund managers, and review them regularly, this sort of research is essential. Research institutes produce good-quality data, including excellent fund manager commentary. However, they don’t rate a fund until it has a solid track record of at least three years. This limitation of the research could lead to you missing out on a new up-and-coming fund in its initial offer.

9. IS PAST PERFORMANCE IMPORTANT?

You will often hear that past performance is not a good indicator of future performance. History may not necessarily repeat itself, but it usually does rhyme a bit. So it’s important to dig deep and review monthly performance to understand how results have been achieved.

Look at periods of high market stress or high market growth to see how the fund has behaved. Has the manager offered good downside protection during periods of market stress? Or has there been excessive volatility during a calm market, or underperformance as a market climbs?

If a fund has performed well, it’s worth checking out why. Make sure that the same proven fund manager who secured the outperformance is still with the company, as managers do change.

10. WHAT PROTECTION SHOULD YOU BE LOOKING FOR?

Read through fund managers’ investment statementsand any other disclosure documents carefully. Doing this research may initially seem overwhelming. But you’ll soon see that each investment statement is written in a similar manner, making it easier to compare fees and processes.

Make sure you read the content and data disclosed in these documents carefully. They have important information, such as expected returns, potential risks to consider, currency-hedging strategies, notice periods required to exit a fund, and minimum investment levels.

Also check who the fund trustees and auditors are. This means confirming that you understand who is policing the fund and checking on their level of independence. If the auditor is not one of the usual large accounting firms such as PwC or KPMG, it’s worth exploring further. On occasions an auditing firm has had connections with the underlying fund manager; this sort of conflict should be disclosed and well understood by you, the investor.

TOPTIPS

• Be thorough in your research.

• Avoid judging a fund manager on historical performance alone, as you may miss some ‘diamonds in the rough’.

• Smaller fund sizes, or concentrated portfolios, can be risky, but can also bring opportunities with the right fund managers.

• Make sure you understand the manager’s processes and limitations, and then closely monitor the funds you select.

The number of funds and fund managers to choose from is immense. Even within each asset class, the number of options and variations can be daunting.

DEFINITIONS

CORPORATE GOVERNANCE: a broad term that covers the set of rules, practices and processes by which a company is directed and controlled by its board of directors. This includes balancing the interests of the many stakeholders in a company, such as its shareholders, management, customers, suppliers, financiers, government and the community.

FUND MANAGER: a fund manager is the title given to an individual, pair or team of people managing a fund’s trading activities and investment strategy.

HEDGE: a way of spreading risk to limit or offset the possibility of loss arising from (currency or commodity) price fluctuations. Usually this is done through making an investment in a related security that you expect to perform in the opposite way.

INDEX: a statistical measure of change in an economy or a securities market. In the case of financial markets, an index is an imaginary portfolio of securities representing a particular market or a portion of it. Each index is usually expressed in terms of a change from its base value, making the percentage change is more important than the actual numerical value.

OUTPERFORMANCE: the act of producing better results than the market or peers.

THE FINANCIAL MARKETS CONDUCT ACT

If you have already made an investment with a fund manager, you may notice that fund offering documents are now shorter and are called ‘product disclosure statements’. You will also be receiving detailed annual reports.

This underlies the more substantial changes which have been introduced under the new law called the Financial Markets Conduct Act.

Behind these changes, which are designed to promote confidence and informed participation in our financial markets, there are a range of operational changes.

Fund managers who offer managed investment schemes to retail clients must be licensed by the Financial Markets Authority (FMA). The schemes must be registered, and have a licensed independent supervisor. Scheme assets must be held by an independent custodian. Quarterly fund updates and a list of all scheme investments must be published.

The FMA considers a range of factors when deciding whether to license a fund manager, including:

• whether its directors and senior managers are fit and proper persons to hold their positions

• whether the manager has people with the right skills and experience to manage the business properly and effectively

• the manager’s systems and processes and financial position.

Existing managers must have obtained a licence and comply with the Act. New managers must do so before they can start business.

You can find out if your manager is licensed by visiting the FMA’s website: www.companiesoffice.govt.nz/disclose

First published 2 May, 2016

By Jack Powell

The editorial below reflects the views of the editorial contributor only and content may be out of date. This article is sourced from a previous JUNO issue. JUNO’s content comes from sources that it considers accurate, but we do not guarantee that the content is accurate. Charts are visually indicative only. JUNO does not contain financial advice as defined by the Financial Advisers Act 2008. Consult a suitably qualified financial adviser before making investment decisions.