Ignore The Hype! How to Pick a Mutual Fund Manager
Too many mutual fund managers seem to follow one purpose: transferring wealth from their clients to their trading desks. I’m reminded of this fact by a recent letter from a reader:
I want to start putting my money in a mutual fund, but how do I pick the right fund manager? How can I sort through the marketing hype and figure out if the fund management is any good or not? — Bill C.
If you’re looking for the best mutual funds for your money in 2017, you first need to look at the quality of the fund’s management. That means sorting through the marketing hype and taking a no-nonsense look at the fund’s prospectus. Below, I show you how.
Evaluate Past Performance
Performing due diligence is vital to hiring the appropriate fund manager. To find the fund manager that best fits your needs, carefully examine the fund’s prospectus to evaluate:
- Variability and consistency of returns;
- Absolute returns, past returns, and returns on a risk-adjusted basis:
- Performance in the context of the fund’s asset class and in the context of its peer group;
- Performance relative to the appropriate benchmarks, including the up and down market-capture ratio (how much of the positive/negative rates of returns the portfolio manager is capturing);
- Amount of assets under management and the amount of time (in years) required to rack up a positive track record;
- The consolidated asset size (not the individual transactions fees).
I want to elaborate on this last point because it’s often overlooked. Instead of fixating on individual transactions fees, look at the negotiated assets-based fee, which should cover portfolio management fees, trading costs, custodial fees, investment management consulting, and any other operating expenses.
Management compensation should be largely comprised of performance-based fees, so your interests and the manager’s interests are closely aligned.
Monitor Ongoing Performance
Don’t hand over control of your portfolio and then put it on automatic pilot. You should never be passive about the management of your wealth, even if you’re paying someone else to manage it for you.
Be sure to perform regular performance reviews of your portfolio and take care to place performance in the wider context of your long-term policies as well as the overall market conditions. Your manager should make all underlying investment activity available to you.
To evaluate manager performance, consider:
- What were the market conditions during the performance review period?
- Did the tangible results meet your expressed goals?
- How much risk did the manager shoulder to reach those results? Are you comfortable with this risk level? Was the risk too low, or too high?
- Are you moving closer to your objectives or drifting further away?
Insist on transparency of trades, so you can measure performance not just in terms of gains or losses but also in terms of returns and risk. Transparency provides the groundwork for you to evaluate manager performance and compare it to your investment strategy.
Reporting of performance should be on both a composite basis and on an individual manager basis. Reporting also should allow for varying levels of analysis along each asset class and each asset style, and on a gross- and net-of-fee basis.
Calculate your returns on both a time-weighted and dollar-weighted basis. The time-weighted rate of return is a superb method to evaluate the money manager’s performance because it minimizes the effects of cash flows. Dollar-weighted rates-of-return measure the portfolio’s total growth.
Weapons of wealth destruction…
Deon Vernooy, chief investment strategist of our publication Canadian Edge, offers this warning about mutual funds, coupled with advice:
“Mutual-fund fees never reached the extremes of hedge funds or private equity funds. But they still manage to charge rich fees linked to the value of the assets under management.
As markets generally rise over time, so do fund assets. As a result, managers earn more without having to do any more work. Our suggestion is simply that investors should be acutely aware of visible and hidden fees included in the funds or other products used to construct their long term investment portfolios.”
Tornado in a trailer park…
I received this letter from a reader, in response to my article yesterday about sectors that will be “yuge” under a Trump administration:
“Few sectors made very much year to date. Technology and small caps rose, but Big Pharma and biotechs suffered. Year to date, the iShares Nasdaq Biotechnology ETF (NSDQ: IBB) is down 20.8% and the SPDR S&P Biotech ETF (NYSE: XBI) is down 13.8%.
I do not understand this at all. My question to you is if you see a possibility that the prices of IBB and XBI will go much higher in the coming months or the present situation will continue without serious change.” — Yair S.
It’s true, biotech short sellers have been having more fun than a tornado in a trailer park. Much of the pessimism stems from worries that the president-elect and Congress will put pressure on drug companies to lower prices, but I think that fear is overblown.
When the political pandering subsides, the drug industry will remain unscathed under a deregulation-minded Trump administration. Several solid biotech companies enjoy robust product pipelines, while populations around the world are getting older and sicker. The biotech sector is home to several undervalued gems right now; I think IBB and XBI are poised to go higher next year.
Got a question? Drop me a line: email@example.com — John Persinos
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