Experts reveal what signals retail investors should monitor to avoid pitfalls with their fund selection.

By: Jean-Baptiste Andrieux,

Reporter, Trustnet

Researching and monitoring funds is a crucial aspect of investing and is indeed something that research teams at wealth management firms spend a significant amount of time doing.

Retail investors do not have access to the same level of tools and resources as manager research professionals and often have limited time available to do their own due diligence.

As such, they are at a significant disadvantage when it comes to spotting funds that might be going off the boil and identifying red flags before they cause problems.

Simon Evan-Cook, fund manager at Downing, said: “This is really hard for retail investors because the information and tools available to them are blunt at best. I suspect this is a regulatory thing, as there seems to be a view that if you give retail investors more tools and information, that they’ll end up doing themselves more harm than good. I have no idea whether this is true or not, but there you go.”

Trustnet asked experts what key aspects retail investors should keep an eye on to spot warning signals.

Put performance into context

Performance is of course a metric to monitor, but it must be assessed within a broader context.

Evan-Cook explained: “This doesn’t mean managers have to always outperform, far from it – we expect great managers to underperform from time to time.

“But it has to make sense, so if a manager follows a value style, we are fine with that if the wider value style has been having a tough time in the market. But if it’s the opposite, this is a red flag.”

Spot style drift

By the same token, Jason Hollands, managing director of Bestinvest, stressed that investors should understand their fund manager’s style and make sure they are not drifting from it.

He said: “When they appear to be straying from their professed approach, this can provide a red flag that something may be going wrong. That could be a value manager buying stocks on hefty multiples or one with a long-term ‘buy and hold’ approach significantly upping their portfolio turnover.”

Concentration isn’t always a good thing

Hollands has a preference for concentrated portfolios as they show that the managers have higher conviction in their picks.

He said: “When you see a notable change in the number of holdings, it might be indicative of lack of confidence creeping in.”

However, he also cautioned against heavy concentration, such as when three or four stocks have a disproportionate weight in the portfolio. “This does increase the risk of the fund and set the alarm bells running too,” he added.

Be wary of large funds

While performance may be the first port of call for retail investors, size also matters.

Darius McDermott, managing director of FundCalibre and Chelsea Financial Services, warned investors to be particularly careful with big funds as they are harder to manage.

“Be wary of big funds, particularly with small-cap, mid-cap or multi-cap, or bond funds. Being relatively small and nimble is key to alpha generation in these types of funds,” he explained. 

Evan-Cook agreed and recommended looking for telltale signs, such as a gradual increase in the number of stocks in the portfolio or a growing exposure to mega-cap stocks instead of small-caps.

However, McDermott also called on investors to be wary of “sub-scale” funds that need to charge high fees to survive.

Keep an eye on flows

If a fund’s assets under management are shrinking rapidly, that might be because other investors may have noticed something concerning under the bonnet, according to McDermott.

Hollands agreed: “It is potentially a signal that large, institutional investors with deeper research resources and access to more portfolio information than private investors have concerns and are deserting the manager.

“Even where this is not the case, when a fund is experiencing major outflows, this can be hugely disruptive, as was the case with the collapse of the Woodford Equity Income fund.”

Yet Hollands also warned that the reverse situation is not ideal either, as rapidly growing assets under management can have an impact on the strategy.

“For example, if past successful performance has partially been driven by investing in smaller companies, rapid growth in assets may impact the ability to take such positions. Likewise, if a fund has historically had a high portfolio turnover approach, actively trading positions, growth in size may make it less nimble,” he explained.

Monitor managers’ behaviour

Investors should also observe the behaviour of their fund managers, said Evan-Cook, although he admitted that this is more of an art than a science.

“Signs of an ego getting out of control are hard to define, but if something arouses your suspicion, you might be better off out than in,” he said.

Evan-Cook also recommended that investors make sure their fund’s manager does not have too much on his or her plate in terms of other responsibilities, for instance if they manage several funds, as it might mean “they’ve taken their eye off the ball”.  

Research key personnel changes

For Hollands, a manager departure is always a time for investors to consider whether the new manager has a credible track record or if they are “unknown quantity”.

He said: “Fund groups will often replace an incumbent with a deputy who may be highly familiar with the process or bring in a new team from outside.”

Corporate change could be a red flag

Finally, investors should also pay attention to potential corporate upheavals that may affect a fund group, be it a merger or acquisition and the subsequent integration or a controversy.

He said: “Institutional consultants – who advise large investors such as pension schemes – will typically freeze recommending companies going through such change until the situation stabilises.”

Please Note:

This article is provided for information only. The views of the author and any people quoted are their own and do not constitute financial advice. The content is not intended to be a personal recommendation to buy or sell any fund or trust, or to adopt a particular investment strategy. However, the knowledge that professional analysts have analysed a fund or trust in depth before assigning them a rating can be a valuable additional filter for anyone looking to make their own decisions. Past performance is not a reliable guide to future returns. Market and exchange-rate movements may cause the value of investments to go down as well as up. Yields will fluctuate and so income from investments is variable and not guaranteed. You may not get back the amount originally invested. Tax treatment depends of your individual circumstances and may be subject to change in the future. If you are unsure about the suitability of any investment you should seek professional advice. 

Please note the above article was first published by Trust Net and should not be regarded as individual investment advice on whether to buy, sell or hold any of the funds mentioned. Please speak to Ethical Offshore Investors or your personal adviser BEFORE you make any investment decision based on the information contained within this article.

As we aim not to use commission paying funds (where applicable), we will access the lowest charging version of the managed fund that is available on the relevant platform…… resulting in more of the investment growth staying in your pocket.

Speak with Ethical Offshore Investments to learn how you can save on your investment costs.

Socially Responsible Investing – Ethical Business Standards