Managed funds
Investing checklist
If you are thinking about investing in of the 12,000 managed funds currently available in Australia,
work your way through the Managed funds checklist below
1. Consider you Investment Objectives
If you are selecting a single asset class fund, then you would have already decided that you
wanted an investment in that asset class. If you are selecting a blended or multi-sector fund, then
make sure that their asset allocation matches your risk profile e.g. conservative.
2. Choose your broad category of fund, such as Large Cap Australian Equities.
3. Explore Morningstar's research to narrow down your choices.
Morningstar rates funds in its database in two ways; it uses a star system of from one to five stars
and a recommendation ranking.
The star system ranks funds against similar funds and is relatively mechanical. The ranking works
over a minimum three year period and looks at returns adjusted by variations in those returns with
an emphasis on downward variations. In other words, how likely is it that the fund meets its
objectives. Five stars is for the top 10% in a category, four stars for the next 22.5%, three stars for
the middle 35%, two stars for the next 22.5% and one star for the bottom 10%.
Morningstar says that its star system "serves as a reasonable way to narrow the universe down to
a subset of funds with strong records of performance" but it also notes that it does not capture all
the factors that will contribute to future returns. It also notes that star ratings are not comparable
across sectors because sectors have inherently different risk profiles. Morningstar says "For
example, a five-star sector-based fund, such as an emerging markets international equities fund,
may have the best risk-adjusted return compared with similar funds within a particular Morningstar
category, but it may be riskier than an established, diversified international equities fund."
Morningstar also does qualitative research - that is research by analysts and has a five point scale
of rankings:- 'Highly Recommended', 'Recommended', 'Investment Grade', 'Hold', or 'Avoid'. Note
that where a retail fund uses an underlying fund, it is the underlying fund that is researched. See
http://www.morningstar.com.au/Funds/MorningstarRatings for more information.
4. Consider entry and exit fees, ongoing management fees and the buy/sell spread.
Case Study
Suppose that you are a novice investor and want a basic investment in blue chip Australian equities.
You recognise the wisdom of holding a number of shares but only have a limited amount of money to
invest which makes it impractical to invest in individual companies. Alternatively, you have the same
objective of investing in diversified, blue chip Australian equities and have sufficient funds but lack the
time, expertise or confidence to invest directly.
You could consider a managed fund focused on large cap Australian equities. There are four
categories within this (blend, geared, growth, value), so you still have some decisions to make.
Assume you decide on a blended approach, then a Morningstar search lists about 330 funds!
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Let's look at a some of these in detail.
To take the first "Highly Recommended" fund on the list (at the time of writing), the AMP-FLI S2Schroder Aus Equities fund. This has no stars because AMP have only been offering it for about a
year. The underlying fund is from Schroders and their equivalent wholesale fund has been running for
some time. The wholesale fund has a minimum investment of $50,000 with an ICR of 0.92% p.a. and
a buy/sell spread of 0.30% on application, 0.30% on redemption. The AMP retail offering has a
minimum investment of $1,500 with an ICR of 1.85% and a buy/sell spread of 0.5%. The underlying
fund achieved an annual return, after deducting their fees, of 2.96% over five years, an
outperformance against their ASX 200 benchmark of 2.1% per annum. Note that, with low absolute
returns like these, the additional fees in the retail offering erode much of this outperformance.
So how about another offering in the same category. The largest retail, highly recommended fund, in
terms of assets under management which are only about $57m (again at the time of writing) is the BT
Fidelity Australian Equities. This has four stars, has no minimum investment, a buy/sell spread of 0.5%
and an ICR of 1.95% and has been running for about three years. The underlying Fidelity fund has
over $2 billion under management with an ICR of 0.85% and a minimum investment of $500,000. This
has achieved an annual return of 3.82% over five years, an outperformance against the index of
2.97%. This fund has been running since 2003 and has achieved an annual return of 12.91% since
inception outperforming the benchmark by 3.93% per annum. The difference between the retail and
wholesale ICR is 1.1% which would reduce the five year performance from 3.82 to 2.72 - a 29%
reduction.
Finally, how about five star, highly recommended, retail funds in this category. The search returned
exactly 1 - the Perpetual WFIF Fidelity Australian Equities. This uses the same underlying Fidelity fund
as the previous BT fund and has been running for about four years which may account for the extra
star. It has a minimum investment of $2,000, an entry fee of 4.0%, a buy/sell spread of 0.5% and an
ICR of 1.95%
The Fidelity Australian Equities fund has done fairly well to outperform the benchmark by 2.97% (after
fees) when the absolute return is so low over the period. So, if you can find a low cost retail fund that
uses this as an underlying manager, you would be making a reasonable decision with the caveat, as
always, that past performance is not necessarily a good guide to the future.
The ASIC web site http://www.moneysmart.gov.au/investing/managed-funds/choosing-a-managedfund gives some further guidance and the Australian Investors Association has compiled some lists of
top performing funds at http://www.investors.asn.au/members/managed-funds-project/default.asp
Australian Investors Association Limited
ABN 75 052 411 999
Investors Helping Investors