Whereas passive funds aim to track the performance of a key benchmark or index, active funds are run by a professional fund manager who selects what goes in the portfolio with the aim of outperforming the market. Active managers are paid a fee by investors for their stock picking expertise, benefit from face-to-face access to company management teams and unlike index trackers, can analyse qualitative data, but keep in mind that most actively managed funds underperform their benchmarks after costs.

The universe of actively-managed funds is vast, with thousands of funds and hundreds of investment trusts available to UK investors; examples include Terry Smith’s Fundsmith Equity (B41YBW7) and Fidelity Global Special Situations (B8HT715) in the funds sector and Scottish Mortgage (SMT) and Alliance Trust (ATST) in the investment trusts patch.

This bewildering array of options can be daunting for the first-time portfolio builder, so to narrow the field, you’ll need to consider the suitability of the investment strategy and the quality of the fund manager and his/or her long-term track record.

FUNDS OR INVESTMENT TRUSTS?

Before pressing the ‘buy’ button, brush up on the salient differences between investment trusts and open-ended funds, as one type of active fund may be more suitable than the other for your goals.

One of the key differences between investment trusts and funds is that the former are closed-ended, and the latter are open-ended. Open-ended means these funds create or cancel new shares depending on demand from investors.

Investment trusts also trade throughout the day, so when you buy or sell, you know precisely what price you’re getting. Open-ended funds work on a forward-pricing basis, so when you place a trade, it goes through at the price set at the next valuation point, often noon the following day.

Investment trusts trade on the stock market like ordinary shares and their share prices can sometimes deviate from the value of the underlying portfolio or NAV depending on investor demand.

Generally speaking, investment trusts are probably better suited to more experienced investors, while open-ended funds can be used by novices and seasoned pros alike.

The existence of discounts and premiums to NAVs makes investment trusts more volatile, because as well as variation in the price of the underlying portfolio, there is movement in the discount or premium. Investment trusts can also borrow money to invest, which is known as taking on ‘gearing’ and can boost returns in the bull markets but exacerbate losses in bear markets.

Funds are suited more to liquid investments such as listed shares and bonds, while investment trusts are better for investing in illiquid assets like commercial property, infrastructure or unquoted private companies. That’s because open-ended funds might have to suspend trading if lots of investors want their money back at the same time. An advantage of the investment trust structure is it allows these companies to use their ‘revenue reserves’ of cash squirrelled away in good times to at least maintain dividends in bad times.

Another consideration is that, for most investment platforms, the cost of trading funds is typically cheaper than for trusts.

WHAT IS THE FUND’S STRATEGY?

One of the major advantages of funds is they allow you to cost-effectively build a diversified portfolio. The many thousands of funds available to the retail investor allows you to choose a particular geographic market, a range of industry sectors or a specialist asset class such as bonds to suit your investment objectives.

Handily, industry trade bodies the Investment Association (IA) and the Association of Investment Companies (AIC) divide their funds into smaller groups or ‘sectors’, enabling you to narrow down choices and make like-for-like comparisons between funds in one or more sectors in terms of performance and charges.

Before kick-starting your actively-managed fund selection journey, you need to make sure the fund’s style and goals fit with your own investment strategy, time horizon and risk tolerance.

A key decision to make is whether to invest in a ‘growth’ or an ‘income’ fund. The most suitable option will depend on your investment goals, risk tolerance and also your age. Growth funds hold shares in companies that are expected to grow at a faster rate compared to the broader stock market heading into the future, whereas income funds seek to provide investors with a source of income right now through dividend payments.

In contrast, income funds target a steady stream of income and may suit the risk-averse investor or portfolio builder closer to retirement, as they tend to invest in more established companies that generate cash and pay dividends. Another style pursued by active managers is ‘value’, which involves buying stocks with low price to book and low price to earnings ratios, or those trading on high dividend yields.

Your next consideration is geographic allocation. Many funds are global portfolios that put money to work in companies listed on the main international markets, whereas others focus on the UK or other developed markets such as the US, Europe and Japan. Other strategies focus on small caps, mid caps and large caps.

JUDGING PERFORMANCE & COSTS

Close scrutiny of past performance can help you to understand the characteristics of a fund and the pedigree of the manager making the asset allocation decisions, although past performance isn’t a reliable guide to future performance.

You’ll still need to assess how the portfolio has performed relative to its benchmark and how is it performing versus other funds in its sector. You’ll also be looking for absolute performance, rather than relative to a benchmark and also to find out whether the past performance shown on the factsheet is the fund manager’s entire track record; the current manager may only have been running the portfolio for short while, rendering historical, long-run data largely irrelevant.

The majority of fund factsheets show total return figures, signifying the return you would have received from reinvesting the fund’s income into the fund. Normally, performance data is provided for one, three and five year periods, stretching to 10 years for more established funds, as well as the performance since launch and in individual years.

Fund factsheets also supply ‘cumulative’ and ‘discrete’ performance data, on a percentage growth basis, the former presented as a graph and the latter as a bar chart on the factsheet. Cumulative performance shows the aggregate performance from a fund from launch over various time periods from launch and represents the portfolio’s overall long-term performance. Discrete performance refers to a specific series of periods.

Don’t rely solely on a fund’s long-term past performance record, since this can potentially lead to a misreading of the bigger picture. For example, a fund with a strong 10-year performance track record may have delivered exceptionally strong performance for the first two years post launch, then produced poor or below average performance for the subsequent eight years.

A manager that beats their benchmark six or seven years out of 10 is doing well and is more likely to deliver consistent outperformance in the future. And before making an investment decision, you should compare the charges that you will pay to cover the costs of running the fund with peers in its sector, since high charges will eat into your returns.

WHERE DO I LOOK?

First port of call for investors assessing performance in the investment trusts sector is the AIC website. Ways of measuring performance include NAV total return, a measure showing how the NAV per share has performed over a given period of time, taking into account both capital returns and dividends paid to shareholders.

Crucially, NAV total return shows performance which isn’t affected by movements in premiums and discounts and also accounts for the fact that different investment companies pay out different levels of dividends. Another measure is share price total return, which shows how the share price has performed over a period of time, taking into account both capital returns and dividends paid to shareholders.

DISCLAIMER: AJ Bell, referenced in this article, owns Shares magazine. The author (James Crux) and editor (Tom Sieber) own shares in AJ Bell.

WHERE CAN I FIND IDEAS?

There are fantastic online sources of information on funds and investment trusts to help with the selection process. For those beginning with funds, the Investment Association’s website is first port of call for the lowdown on fund sectors and statistics, while the AIC website is jam-packed with data, documents, articles and research to keep you informed.

Using data from Morningstar, the AJ Bell website enables you to filter funds and investment trusts performance and the site is flush with fund-related articles and fund manager videos. Here you will also find the AJ Bell Favourite funds list, the platform’s pick of funds offering the combination of excellent fund management, low charges and best long term potential performance. Trustnet is a fantastic resource for factsheets and fund performance data and topical articles, while investment trust aficionados should check out the Kepler Trust Intelligence and QuotedData websites for in-depth research notes.

USEFUL WEBSITES

www.ajbell.co.uk/investment-ideas/favourite

www.theia.org

www.theaic.co.uk

www.trustnet.com

www.ajbell.co.uk

www.quoteddata.com

www.trustintelligence.co.uk

‹ Previous2024-06-20Next ›