How to pick a good investment

If you want a sure fire way to pick a good investment fund what is the best method? Past performance? League tables? Manager skill? Star ratings? A dart board? The bottom of your tea cup? Actually the answer is very simple, writes David Norman, managing director of TCF Investment.

We looked at the returns of the three IMA (Investment Management Association) Managed sectors. It ranked all the funds in the sector by current Total Expense Ratio (TER). It then looked at the performance of the low cost quartile (cheapest 25%) and the highest cost quartile (most expensive 25%) relative to the average performance of all funds over 3 and 5 years:

Sector

Quartile Cost

Performance

3 years %pa

Performance

5 years %pa

ACTIVE

Cheapest

6.36

4.59

 

Dearest

5.20

3.52

 

Dearest  less cheapest

1.15

1.08

 

Sector average

6.16

4.14

 

 

 

 

BALANCED

Cheapest

6.26

3.94

 

Dearest

5.16

3.04

 

Dearest  less cheapest

1.10

0.90

 

Sector average

5.81

3.68

 

 

 

 

CAUTIOUS

Cheapest

5.05

2.90

 

Dearest

5.05

2.31

 

Dearest  less cheapest

0

0.59

 

Sector average

5.19

2.7

Source : Morningstar 2011

The analysis shows that the lower costs are a very strong predictor of future returns – beating or meeting the returns from their higher cost peers in every case. 

Yet despite the clear evidence of the pivotal significance of cost when choosing a fund, there is effectively no price competition across the UK fund management industry.  Investors and their advisers need to take a proper, careful look at Total Expense Ratios (TERs) and Portfolio Turnover Rates (PTRs) of funds when choosing one fund over another.

Put another way, investors and their advisers need to remember that every pound of investment cost is a pound lost – forever.  In the current low return environment high costs means investors are effectively trying to walk up the down escalator – a sure fire way to get nowhere fast.

 

 

Monday 14th November 2011