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Crunching the numbers – how HL’s Research team spot talented fund managers

We take a look at how our Investment Research team use data to select actively-managed funds for the Wealth Shortlist.

Important notes

This article isn’t personal advice. If you’re not sure whether an investment is right for you please seek advice. If you choose to invest the value of your investment will rise and fall, so you could get back less than you put in.

This article is more than 6 months old

It was correct at the time of publishing. Our views and any references to tax, investment and pension rules may have changed since then.

Where do we start?

With thousands of funds available on the market it can be difficult to know where to start.

Before our Investment Research team dive into the detailed analysis to select funds for the Wealth Shortlist (funds we believe have the greatest performance potential), we make sure they meet a certain criteria. For example, funds that make the list must be available to retail investors in both Stocks and Shares ISAs and Self-Invested Personal Pensions (SIPPs).

From there, our analyst’s specialise in and monitor specific fund sectors to identify the ones with the greatest performance potential. We do this by using data (quantitative analysis) and by speaking to fund managers (qualitative analysis). In a recent article, we looked at why incentivisation and culture is an important part of our research process.

The Wealth Shortlist has actively-managed funds that we believe can outperform their benchmark and peers over the long term. But also, index-tracker funds which aim to track their index as closely as possible. In this article, we take a look at the process behind selecting actively-managed funds.

Looking at the whole picture

Quantitative analysis to some, number crunching to others. Either way it’s an important part of our research process. Managing people’s hard-earned money is a big responsibility and not everyone is well suited to it, so we need to analyse a fund manager’s track record to see how they’ve performed over time.

Most fund managers will switch jobs and work for different asset management companies throughout their careers. It’s no different to any other industry – less and less people stay with one employer throughout their working life. Looking at a fund manager’s record with their current employer won’t always be that useful, though, especially if they’ve recently decided it’s time for a change.

That’s why we track the performance of fund managers across their entire management career – where they’re working now and where they’ve worked previously. Stitching together the manager’s tenure across different roles allows us to build and analyse their career track record from start to finish. This helps paint the whole picture of the ups and downs they’ve experienced in the past.

To be considered for the Wealth Shortlist, fund management teams must update their portfolio data regularly. Not only does this offer greater transparency on where the fund is currently invested and how it’s changed over time, but it also helps our analysts understand the manager’s investing style. If a manager has performed better than what their style suggests, we put this down to excellent stock-picking – an attractive characteristic.

Beating the benchmark

Active fund management is all about outperforming the benchmark in the areas they invest in over the long term. For example, a fund that invests mostly in the UK would normally be benchmarked against the IA UK All Companies sector. We’d consider this as a ‘fair’ benchmark.

We look for managers who’ve performed better than a fair benchmark over their career. While this doesn’t mean they’ll continue to outperform in future, it gives us a good idea about a few key areas:

  • How they’ve navigated difficult market conditions. It’s not always plain sailing when investing – it’s important to review the manager’s performance in choppy waters too. For example, the financial crisis in 2008.
  • How they’ve performed throughout the market cycle. Like most things, markets come in and out of fashion. We think it’s essential to understand how the manager’s philosophy, style and process holds up under different economic and market conditions.

Understanding what’s driving performance

While it’s good news if a fund has outperformed its benchmark, it’s important to recognise whether this is because of good stock-picking, or if it’s just because their investing style has been in favour.

We like managers who can add value through stock selection, as it shows their investment process is consistently leading them to invest in the best opportunities. Managers capable of repeating this can often lead to significant outperformance compared to their benchmark over time.

Some managers don’t aim to add value through stock selection though. Some look to benefit from investing in a mix of investment types such as shares, bonds and cash – also known as asset allocation. As some asset types perform differently at different times, how the manager spreads investor’s money across different asset types can have a big impact on returns.

That said, it’s easy to get lucky over a short timeframe. We prefer managers to have a track record of at least 7-10 years and ideally even longer.

Risk metrics

Risk is another key factor in the quantitative analysis process. It includes things like:

  • Liquidity – can the underlying investments be sold easily should investors want to sell their units in the fund?
  • Size of the fund – has the fund grown too big? Can the manager still make the most of the opportunity presented to them?
  • Fund inflows and outflows – is the fund’s size getting bigger or smaller?
  • Underlying investments – where is the fund invested? Does the fund invest in smaller companies which add risk?

Risk can also be considered when looking at the fund’s performance. For example, how it performs in different environments and what the potential downside risks or losses might be.

Some managers use more aggressive investment styles so they might suffer bigger price swings when markets are volatile. Others focus on sheltering investor’s money when markets take a turn, which means they may lag behind in a rapidly rising market. There’s no one right way to manage money – it’s about recognising a manager’s style and making sure it matches their performance profile.

Bringing it all together to build the Wealth Shortlist

Combining the hours of number crunching and meeting directly with the fund managers helps us to create the Wealth Shortlist. And funds that make the grade are chosen by our analysts for their long-term performance potential.

The Wealth Shortlist isn’t a one-off process. Our research team constantly monitor the list and we add and remove funds using a strict selection process. It’s important for investors to regularly review their own investments to make sure they still match their goals and attitude to risk.

More on how we build the Wealth Shortlist

We have a range of different fund styles represented on the Wealth Shortlist. After all, there’s no ‘right way’ to invest. What’s crucial is that the manager has a long track record of outperforming its benchmark, and has the potential for this to continue in the future.

Funds on the Wealth Shortlist won’t all perform the same way at the same time. If you invest in two funds in the same sector, which are performing well at the same time, they're probably investing in similar areas. That's great when those areas are in favour, but can be a painful watch when they're out of favour.

It’s important for investors to build a diversified portfolio with managers who have different approaches and investing styles, which invest across various investment types, geographies and sectors. Doing this should better your chances of performing well over the long run.

Remember though, a strong track record doesn’t guarantee outperformance in the future, and of course, investments rise and fall in value, so you could get back less than you invest. This article, like our Wealth Shortlist, isn’t personal advice. Seek advice if you’re not sure.

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See all the funds selected by our analysts

The Wealth Shortlist is designed to help investors build their own well-balanced and diversified portfolios. We put funds under the microscope to make sure the list only contains the funds that our in-depth analysis indicates have the greatest performance potential.

Find out more about the Wealth Shortlist

What did you think of this article?

Important notes

This article isn’t personal advice. If you’re not sure whether an investment is right for you please seek advice. If you choose to invest the value of your investment will rise and fall, so you could get back less than you put in.

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