Last week we looked at choosing the best funds for your ISA and the key points investors need to know. In this post we'll continue with this important subject and focus on identifying funds with real growth potential.
How to pick the best funds
We are often reminded that past performance is no guarantee of future performance, however when you view past performance in a different light, it can help give you an edge when choosing the best funds to buy. When choosing the best fund manager to park money with, sophisticated investors think in probabilities rather than certainties. Nothing is guaranteed when investing in the stock market, which means you need to do all you can to increase the probability that the fund manager you choose is ‘likely’ to continue to perform well in the future. For those who like their rewards a little higher for their ISA, our suggestion would be to aim to find fund managers with outstanding track records. This approach may or may not work for you and there is no guarantee it will produce better results. When the market is in a confirmed uptrend, we scan for funds managed by exceptional fund managers. We like to ensure that the fund manager has proven that they can beat the market in the short and the long-term.
You need a benchmark to find the best funds
If you followed a similar strategy to ours, your aim would be to make sure the person managing the fund has outperformed the market in the long-term and in the short-term. How do you do that? You need to compare their performance versus a benchmark, such as the FTSE 100, the S&P 500 or the Nasdaq Composite. Most fund managers underperform the S&P 500*, which has averaged 13% per year over the long-term.
*Source: "Assessing the Costs and Benefits of Brokers in the Mutual Fund Industry" by Daniel Bergstresser of the Harvard Business School & 2004 Dalbar Quantitative Analysis of Investor Behavior
Returning 13% on average every year is pretty good and probably the main reason why so many fund managers fail to beat it. Even though 90% fail to beat the market, 10% do beat it and these are the fund managers we like to focus on. When looking for a quality fund manager, we discover if the fund manager has good long-term performance and the way to do that is by comparing their annual returns with the Nasdaq Composite's returns.
When we find exceptional fund managers we often notice that they not only beat the market in one year, they beat it in multiple years and that means beating the market was not achieved by luck. We then assume that the manager could be an Alex Ferguson of the fund world. Because that manager has achieved a great track record, the probability that they are going to continue to perform well in the future is high. As well as looking at how these fund managers have performed year on year (long-term) we like to make sure the fund manager has proven they can outperform the market in the short-term. This short-term analysis allows us to see which managers are really in sync with the market. The best ones will be those that are holding the market's leading stocks and, when we look at their recent short-term performance, we generally see that they have easily been beating the Nasdaq.
Beware, some top fund managers are not ‘in sync’
Some fund managers with great track records will unfortunately not be in sync with the market all of the time. Why? Each fund manager has a fund mandate. The mandate is a statement of its aims, the limits within which it is supposed to invest and the investment policy it should follow. As part of this mandate, a fund will have to define what countries or regions it will invest in and what sectors it will invest in. Fund mandates are set by the fund management company, but publicised so that investors can choose a fund that suits their requirements.
A mandate puts managers at a disadvantage because the big money can only flow into a handful of countries/sectors, rather than it flowing into every country in the world and every given sector. At ISACO our ISA investment expert has the luxury of being flexible, nimble and totally unrestricted. It means he can invest anywhere in the world and that means he is never tied to any one fund or fund manager. His only concern is to be invested in the money flow. His mantra is to invest with star-performing managers who hold stocks where the big money is flowing right now. These are the fund managers he classes as being 'in sync' with the market. These are funds controlled by a manager who has not only proved they can beat the Nasdaq in the long-term, they are also beating the Nasdaq in the short-term.
The importance of investing with the market's trend
You can choose the best investment fund in the world but if you invest in it and you are wrong about the trend of the market, your portfolio is going to suffer. This happened to thousands of uninformed people in the great bear market of 2000-2002 and in the most recent bear market of 2007-2009. Many people mistakenly think that it is all about choosing the best fund to park your money in. Whilst finding a high quality fund is important, it’s not as important as getting in sync with the market’s trend. Therefore in your analytical toolkit, you absolutely must have a reliable method to determine future market direction. And if your desire is to become proficient, it is going to take time and patience.
Throughout your investment journey you will ideally need to know if you are in a bull (up) market or are you in a bear (down) market. In an upwards trending market, the market is classed as healthy but in a downwards trending market it’s classed as unhealthy. This is an important concept to grasp because in rising markets, when the market is healthy, 75% of funds will rise. However in falling markets, when the market is unhealthy, 75% of funds will fall. This means when a downtrend has been triggered, your aim should be to get more defensive and possibly move your portfolio into a cash park to preserve your profits. When you invest against the market's trend, it’s like trying to swim against a strong current; virtually impossible to make any headway.
Aiming to accurately time your fund buys
On sites like www.morningstar.co.uk you can view a fund's chart, which we believe can help you get a better entry point when buying a fund. Charts help us to look for patterns that suggest future behavior. With the fund’s chart, we look for bullish chart patterns such as cup-with-handles, flat bases, saucers-with-handles and double bottoms. In our opinion, it is best to purchase quality investment funds as they break out of a sound base. A more risky strategy is to buy when the fund is building the right side of a base.
Buying a fund late is also risky. This is when the chart pattern shows it has broken out of a base and is currently trading at 10% or more past its proper buy point. Funds extended past their ideal buy point are much more likely to correct after you have made your purchase. This would turn a possible temporary gain into a loss. The rules we follow when buying a fund are simple; buying early or buying late adds risk. The aim is to buy at the optimum time, which is when the fund is breaking out of a sound base.
For those who like their rewards a little higher
If you are an ISA or SIPP investor with over £100,000 actively invested and would like to know how it’s possible buy the same funds as a star-performing investor, you may be interested in our personal investment service. You find out where an expert invests, keep full control of your account, enjoy a close relationship, and benefit from the potential for attractive long-term returns.
Our service is an innovative investment solution where a leading investment expert carefully reviews, evaluates and selects the most appropriate funds for his ISA portfolio. The expert’s unique approach and skills ensure that his portfolio is reviewed on a daily basis to ensure they are performing to expectations and making changes where needed. His money is invested across a wide range of funds and geographic areas, which is aimed at getting potentially better returns over the medium to long term, whilst also mitigating the risk of investing in single funds. The service is designed for private investors who seek ISA and SIPP guidance from experts, but ultimately want to manage their own investment accounts. This service does not constitute a personal recommendation. Should you have any doubts as to the suitability of an investment for your circumstances, we suggest you speak to a financial adviser.
I hope you've enjoyed this post. As always, if you have any questions or thoughts on the points I've covered, please leave a comment below or connect with us @ISACO_ on Twitter.
Please note past performance should not be used as a guide to future performance, which is not guaranteed. Investing in Funds should be considered a long-term investment. The value of the investment can go down as well as up and there is no guarantee that you will get back the amount you originally invested.