Managed Funds, be warned

Consider the following very carefully before investing in managed funds:

  Performance is one thing...

You will hear all about a few of the top performing funds and nothing about the rest. Be wary of a fund manager who shows you the performance of "a selection of our funds". You will be seeing just the pick of the bunch.

Realise that average fund performance is ordinary; half of them under-perform and many go backwards.

Examine fund performance over a 5 year period as a starting point. Certainly assess how a fund has performed since inception and over at least the past 3 years and one year – but 5 years is best.

Ask yourself questions like “has the three year return been inflated by a huge performance 3 years ago and the fund languished since”? In this regard check out our comments on top funds.

And of course a fund that performs exceptionally well one year may dawdle or go backwards the next.

  Does it meet my objectives?

Be clear in your own mind as to why you are investing (deposit on a home, children’s education, holiday, retirement, all of these) and what you seek to achieve. Sure, we all want to maximise our returns, but it will help if you know whether you are looking for capital growth, income, tax effective income or a combination of all of these. Understand how your investment objectives could influence your choice of fund.

  Is the risk too great?

Try to understand the relationship between risk and return and what your risk profile is. Here is a little graph that demonstrates it:

Some people worry about quite small risks while others are happy taking a bigger risk.

You can make a quick assessment of your risk profile here, courtesy of Colonial First State. This is how fund manager, Perpetual Investments, in a graph on page 2 reflects risk and return. (As a general rule, the bigger the potential return, the higher the investment risk, but you will note that is not always the case.)

  Will it give me the right mix?

Knowing your risk profile helps you choose the asset class and investment mix that is right for you. If, for example, the security of your savings is of prime importance to you, pick a lower risk fund and sacrifice some of the higher potential returns from a riskier fund.

It is important to realise that 95% of your investment returns will depend on the types of asset classes (shares, listed property, international funds and so on) that you select rather than the specific fund manager chosen.

  Do I understand the fees?

Investors are warned that small differences in fees can have a substantial impact on long term returns.

But don’t be overly influenced by fee levels – the real objective is to find a fund that provides the best net returns. Read more in Fees and other costs.

  What is the impact on me of tax?

Dividend imputation also applies to managed funds which hold Australian shares and receive franked dividends. Capital Gains Tax (CGT) results when 1) investors sell units in the fund or 2) when assets within the managed investment are sold by the manager. Read more in Tax consequences.

  Should I go listed or unlisted?

Note that this section on managed funds is more concerned with unlisted rather than listed funds (see below).

Unlisted funds are either “open” or “closed”. Open funds issue new units regularly to meet demand. The unit value of both is determined and published weekly or even daily by dividing the value of the total assets by the number of issued units.

The fund’s prospectus usually spells how long it takes to access your money if you want to sell – it should not take longer than two weeks, more often it is a matter of days.

(Listed funds are traded on the market. The most common are listed property trusts (LPTs) and listed investment companies (LICs). )

   Should I go income or growth

 Funds fall into these two broad groups:

 Income - Cash, fixed interest and mortgage funds are mainly ‘income’ investments — their returns are more stable and foreseeable.

 Growth - Property and shares are more ‘growth’ investments with greater volatility and the potential for high returns. (They can also provide income from rents or dividends).

 Further Reading: Spanner in the works (Annette Sampson, SMH - Sep 2012)