How Do I Choose A Managed Fund?

I recently had a reader ask, “how does an amateur like me begin to independently try and assess managed funds?  Are there any independent rankings, or research?” And indeed it’s a good question, and in the past I’ve wondered how I should choose a managed fund for family investments. You see, most of my own capital is invested in my own portfolio, but my family does invest in some managed funds.

There are lots of reasonable ways to go about choosing a managed fund, and the government would certainly instruct you to consult a financial adviser. So, assuming one has first consulted a financial advisor for personal advice, I’m happy to share a few general considerations that have been important for me, whenever I have invested in a managed fund.

2 Rules For Choosing A Managed Fund

1) Invest with a fund manager, not in a managed fund.

It is extremely important to realise that corporate entities have no ability to sustain a track record or do anything. Rather, you should be thinking about a managed fund in terms of who the actual portfolio manager taking responsibility for the investing is.

I don’t invest in a managed fund, I invest with a fund manager. If that fund manager left the fund, my thesis for investing with the fund would be invalid. Equally, if that single fund manager hired 10 analysts and purported to manage the portfolio of 5 different funds, it would invalidate my investment thesis. Indeed, for me, it is generally unacceptable that one fund manager would manage two separate funds. I can find fund managers who solely manage one fund. A different fund manager would have to be about twice as good to entice me to invest in his or her fund on which he or she only spends 50% of his or her time.

2) Greater funds under management (FUM) reduces returns.

It is categorically undeniable that it is more difficult to generate outperformance with $500 million compared to $50 million. Ideally, then, I want to invest in fund managers with smaller funds, who will grow assets more by getting good returns than by accepting new monies. You may see a strong performing small cap fund that, over a few years, grows from around $100 million to around $450 million. This meaningfully reduces its nimbleness and opportunity set. Again, the fund manager running $500 million needs to be significantly more skilled than the one running $100 million, to be equally attractive to choose.

How Should You Choose A Fund Manager?

Generally speaking, I only invest in fund managers that I have known for years as investors before they become fund managers. Once a fund manager has already proven their track record as part of their fund, they will generally attract hundreds of millions of dollars and it will be too late for me to make my investment with them. Therefore I look for younger top notch investors starting their first fund. This is not be the safest way to go, so you should check with your financial advisor before making any decisions.

My family currently invests varying amounts with 5 different fund managers. All of these people convinced me of their skill as an investor by making many great calls in real time in front of my eyes, over the course of years. I believe that they all manage less than $100 million, though some are getting close to that level.

Each investor has a different strategy, but the general theme is you want individuals that are more motivated to grow funds under management by performance rather than inflows. I would expect that with time, any of those managers could end up managing as much, or more, than their strategy reasonably supports. It will be up to me to decide when to exit the investment, which I will do, on the basis of FUM growth, despite the fact I count each of them as friends.

In any event, the way to research a fund manager is to go out and see what they were saying a few years ago, and then see if they convince you of their skill. You will need to find as much evidence you can, of both mistakes and successes.

The most important thing is to choose a fund manager you can trust. As an investor in a managed fund, trust and affinity are most important metrics to consider, because you may be spooked out of your investment at a bad time, if you do not properly trust and like the fund manager.

Therefore, in an ideal world, you’ll have observed your fund manager’s career for a few years at least. Decent ethics, both in their general life and in the companies they back, can be important. Running a listed investment company (a LIC) for example, would be disqualifying from my point of view, because it unethically forces your investors to liquidate their investment at below net asset value, by removing their ability to redeem their investment by request. Equally, I would question the ethics of a fund manager who thinks its clever to invest client money in tobacco stocks.

One thing that should be considered but should not be over weighted is fee structure. I can think of a fund manager with very high fees, which actually caused me not to invest, who has done extremely well for investors. Equally, I can think of a fund manager who charges performance fees only, who has underperformed the market for years. The under-performer also spend a lot of time on twitter posting regular calls to let covid spread prior to vaccines being available.

On thing that is extremely important is whether the fund manager invests a significant amount of money in the actual fund. Generally, I would only invest in a fund where the portfolio manager is:

  1. investing the majority of their wealth in the fund.
  2. running only one fund.
  3. managing an appropriate amount for their strategy.
    • no clear rule here, but a good rule of thumb is that most small cap strategies work best with less than $50 million, and are severely hampered by $250 million. In contrast, active microcap strategies might stop working well by $50 million, and work best with less than $5 million.
  4. completely trustworthy without any doubt.
  5. proven beyond doubt to be a market beating investor.

How Do I Choose An Investment Fund?

The short answer is that, after taking appropriate financial advice, I focus on the fund manager, their track record, their trustworthiness, and their incentives.

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