The FTSE 100 index has risen 25% since its low of 3,287 on March 12. The latest figures from the Investment Management Association show that investors put £918m into managed funds in June — 24% more than in May, and 45% more than in June last year.
Gavin Oldham at The Share Centre, a stockbroker, says: “The markets have been trading in a range for a while now. The FTSE 100 doesn’t seem to be able to break through 4,200, but nor is it falling below 3,900. I think these conditions will prevail for the next couple of months, but the market could rise in the autumn and end the year at about 4,500.” The Footsie closed at 4,098 on Friday.
First, you need to decide what type of fund to invest in. Do you want income or growth? Do you want to stick with Britain or would you like exposure to a different market? The decision will depend largely on the other investments in your portfolio, your objectives and your attitude to risk.
Anna Bowes of Chase de Vere, an adviser, says: “In an ideal world, you would always invest in a fund that will do best in the prevailing market conditions. But identifying these schemes in advance is virtually impossible. You should therefore try to build a balanced portfolio of different types of fund, so you should always be able to make a profit somewhere.”
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Performance figures
Impressive short-term performance tends to attract a lot of attention, but research from M&G, an investment company, shows that between 1998 and 2002, the top ten funds in one year were laggards the next. For example, in 1999, nine out of the ten top performers were Japanese funds yet the following year none ranked higher than 1,300. Instead of trying to spot the next star performer, many investors prefer to look for consistent funds.
You should compare a scheme with its peers as well as a benchmark. For example, Investec UK Smaller Companies has fallen 5.62% over the past three years, which looks disappointing.
However, the FTSE Small Cap index is down 28.66% over that period and the average fund in the sector has dropped 33.95%, according to Standard & Poor’s, so the fund has actually done very well.
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Manager’s record
The fund manager’s track record is important. Citywire (www.citywire.co.uk) and Bestinvest (www.bestinvest.co.uk) provide information on fund managers. You should then be able to assess whether their success is more down to luck than judgment.
It can also help you make decisions if a manager is new to a fund or switches to a rival firm.
For example, Tim Russell moved from HSBC to Cazenove last year and advisers now recommend the Cazenove UK Growth & Income fund. Yet when Chris Burvill left the Investec Cautious Managed fund to go to Gartmore, experts did not change their view of the Investec scheme.
Fund risk
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Performance is important, but so is the amount of risk the manager takes with your money. Certain types of scheme are riskier than others. Some funds — for example, those that invest in a single sector, specialist regional schemes or focus funds that can hold only a limited number of stocks — will be more volatile than funds with a broader investment remit.
Generally speaking, riskier funds have the potential to deliver higher returns in a rising market, although they tend to fall further in adverse market conditions.
A number of indicators can help investors to gauge volatility. The “standard deviation” is expressed as a percentage and shows how much returns have fluctuated over a set period against its average daily return. A high-risk fund will therefore have a higher standard deviation than a lower risk scheme.
If you want to work out the likely return for every unit of risk, you need to study the “Sharpe ratio”. It measures performance versus absolute risk — in other words how much a fund has typically outperformed a risk-free asset, usually cash or gilts. It is calculated by dividing a portfolio’s standard deviation by the difference between its returns and the returns on cash or gilts.
A low figure indicates a disappointing return relative to the risk; a negative figure suggests you would have been better off in cash or gilts.
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For example, the Gartmore High Yield Corporate Bond fund has the highest one-year Sharpe ratio at 3.44. Performance is up 12.92% over 12 months. First State Cash, on the other hand, has the lowest Sharpe ratio — minus 59.69 — and has delivered returns of 2.55%.
The “information ratio” measures performance in relation to relative risk. Instead of being calculated against a risk-free asset, it is worked out against a benchmark, such as the FTSE 100.
Bowes says: “The information ratio shows the skill of the manager because you can see the returns he or she achieves when deviating from the benchmark.”
Websites such as www.funds-sp.co.uk and www.morningstar.co.uk provide details of these measurements. A figure of 0.3 or higher is regarded as a good Sharpe ratio; anything greater than 0.5 is a decent information ratio.
Philippa Gee at Torquil Clark, an independent financial adviser, says: “You should never look at a single factor in isolation. You have to consider different characteristics and get a feel for the fund and what it is trying to do.”