Consider Fund Sectors
Eh? What are fund sectors?
Fund sectors help you choose which funds to invest in. All funds are grouped according to certain investment criteria, and these groupings are called fund sectors.
The nice people at the Investment Management Association dreamt up sectors. They are recognised across the industry and cover all areas and types of investment funds.
In the last section we told you about different types of investments acting in different ways (e.g. bonds are usually less volatile than equities). The same rules apply to fund sectors. Take the U.K. Corporate Bond Sector. These funds are a lot less volatile than, say, those of the Japanese Smaller Companies Sector. There's a trade off though: Corporate Bonds are also less likely to give you a very large return over the same time period.
It's the same old story: do you play it safe, or take a risk and go for the really big money?
Choose the Sectors That Meet Your Own Investment Objectives
Kick off by deciding which sectors would suit your portfolio best. Only then should you start checking out the funds within those chosen sectors. Choose a range of sectors that suit your needs, and you'll be sure of a portfolio containing a diverse range of funds.
If a low risk portfolio's your thing, the best bet could be the UK. You might want to bung the majority of your investments in a UK bond or gilt sector, and invest a small proportion in a UK equity sector.
Another investor, after working through our first 3 sections, might decide that they'd like the equity part of their portfolio to contain small sized American companies.
A good place for them to start looking would be funds in the North American Smaller Companies Sector. They would then know that although there will be other differences between the funds in this sector, they would be investing in the right area.
Pick the Funds Themselves
Right. You've chosen the sectors that suit both your investment objectives and your attitude to risk. You can now start assessing the funds themselves. It's important to compare funds using a range of criteria. Take a gander at:
- fund objectives
- official fund ratings
- past performance
How can fund objectives can help you choose?
Like investors, Fund Managers have a stated set of criteria and objectives, which they follow to invest your cash in their fund. You need to make sure that the fund objectives don't contradict your own.
Here's a 'for example.' Let's say you've decided to accept a higher level of risk and want to invest over a long period to maximise the fund's potential for growth. You'd probably want to steer clear of a Fund Manager who favours low volatility and manages his fund conservatively.
How can fund ratings help you choose?
Funds and the managers are regularly reviewed and given ratings and awards by top City institutions. And these guys don't just hand out awards willy-nilly either; their assessment criteria are very strict. A number of companies do this, and one of the best known and respected is Standard & Poor's (S&P) who use two different types of ratings, a star rating and a fund rating.
These star ratings are awarded to funds that show a consistent level of high performance over the previous 36 months, with 5 star funds being the highest rated in their sector. Their coveted fund ratings are awarded for the investment style and management of a fund. Currently only 20% of funds qualify for these fund ratings, so those with the highest AAA rating are well worth taking a closer look at
Having said that, a fund without a rating isn't necessarily a bad fund. There are a bunch of reasons why perfectly good funds don't get awards. They might have acquired a new fund manager, or only existed for a short while. All told, it's better to use ratings as part of a range of criteria, and not just on their own.
How can past performance help when choosing funds?
When selecting a fund, most people will base their decision on its past performance. In fact, take a peek at the Sunday papers and you'd be forgiven for thinking that past performance is the only thing to consider.
But there's some other stuff you need to watch out for:
- for one thing, it's worth considering the time frame of the fund's performance, in other words how long has it been measured for. Funds can be very volatile, performing just dandy one year only to go down the tubes the next.
- fund consistency is also important. One way to identify consistent performers is to look at their year on year performance over a number of years. Just because a fund has a tip-top performance over the last 6 months, doesn't mean its 5-year record will be quite so rosy.
How do you decide whether a fund's past performance has been good or bad?
Easy. Compare the funds' performance against other funds in its sector. Then check the average performance of all the funds in that sector. That way, you're sure to compare funds with similar objectives. In other words, you'll be comparing apples with apples, and not apples with oranges (or pineapples. Or bananas).
Judging a fund's performance becomes a doddle when you start thinking about Indices.
All funds choose an Index that they wish to be compared against. This Index tells you how the market the fund invests in has performed as a whole.
For example, a fund that invests in large UK companies might choose the FTSE 100 as its benchmark. You can then compare the performance of the fund against the performance of the FTSE 100 (i.e. the market in which the fund operates).
If a fund performs consistently better than its chosen Index, we can say that its managers are able to 'beat the market' by selecting the right kind of investments. Again, this is dead handy; it lets you assess the fund's performance within its chosen sector.
So. Past performance is a useful way to help select funds. However, don't forget that past performance is no guarantee of future success. There are a bunch of reasons why a fund's past performance may no longer be worth the paper the statistics are printed on.
For example, the fund manager could have left, the fund's criteria may have altered, or the fund may have had a never-to-be-repeated lucky patch. So beware, folks: view a fund's past performance within the context of its sector, and in conjunction with all the other selection criteria.
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