Linda Gu of Morningstar explains the approach that advisers and investors should take when assessing individual funds, to ensure they make the right buying decisions as part of the overall asset allocation process.
Date: Apr 2011
So while taking more risk in good times can lead to higher returns, investors need to be ready for the cycles of the market and ensure their portfolio is well-positioned, she explained.
When it comes to risk management, Gu said it is key for investors to understand how comfortable they are with downside risk.
This means looking at the volatility of a fund and understanding the likely ups and downs over time. For example, she said, conservative investors don’t want to put their money in funds where they might potentially see a drop of 50%.
Understanding how a fund compares with its peers, therefore, and analysing if the fund truly delivers risk-adjusted returns, are important aspects of picking the right investments, advised Gu.
Assessing funds within the overall asset allocation
According to Gu, it is key to educate advisers and investors about performance. In Asia, in particular, investors look at performance over a certain period and might see that a fund has returned 100% or 200%, for example, so chase these returns by putting their money into these funds.
However, said Gu, it is critical to look beyond just the headline performance – and instead at what drives this, by analysing the underlying holdings of the mutual fund.
Advisers also need to really understand who has been responsible for delivering performance, she added, especially since the majority of it might have been generated by a manager who recently left the company, for instance.
Further, said Gu, when investors look at top-rated funds, the rating could mean that a lot of investors have been putting money into the fund after several years of strong performance – and therefore when prices are high.
Being “true to label”
Gu said it has also been interesting to see that while a fund manager might claim to be a value manager, for example, a look at the underlying holdings might show this manager to in fact be more growth-oriented.
There are many examples where fund managers deviate from the investment style they claim in their prospectus, she explained.
As a result, advisers and investors need to focus on whether the manager is true to the style in which they want to invest their money.