Fort Bend Independent Articles

2010-08-01 The Four ''EXs'' of Evaluating and Selecting Mutual Funds

According to a report from the Investment Company Institute, there are more than 65,000 mutual funds offered worldwide. This abundance of alternatives presents investors with a dilemma. On one hand, having multiple options allows consumers to compare managers to their peers and gain access to traditionally restricted markets. But then you have to ask yourself: which one?

In today’s technologically advanced world, there is an incredible amount of data available on mutual funds. But instead of leading to better investment decisions, often the over-saturation of information leads to decision paralysis. For example, is it better to buy a fund with a longer track record or better short-term performance? Should you buy from a manager who invests for value or growth?

Following are four factors that will help you sift through the world of mutual funds to separate the great managers from the average and poor.

Experience

Tenure and time cannot be underestimated when evaluating a manager. The more time a professional has had to hone his or her craft, the better the end product should be. A manager with little experience typically won’t know how to navigate through the ups and downs of the market, thus putting your financial assets at risk.

It is important to differentiate between how long the fund has been in existence and when the manager took over the fund. When you buy a fund, you are really buying that manager’s skill and experience. If the manager leaves the fund, so does all the performance and accomplishments that were achieved during his tenure.

Execution

Performance isn’t everything, but if a manager can’t add value over the long-term, he isn’t worth investing with. When evaluating the success/failure of a strategy, it is best to start with the long-term returns. Studies show that while past success does not guarantee future success, bad managers typically don’t get better.

Don’t overemphasize recent or short-term performance. Some of the best managers in the world can and will underperform for as long as three years at a stretch. The point is to find the right managers for the long haul.

Expenses

The average mutual fund charges about 1.5 percent annually for management expenses. Many funds can cost upwards of 2 to 3 percent. This is important because every dollar taken from investors has to be made up in performance to add value. It is very difficult for a manager to add more than 1.5 to 2 percent above a benchmark in the long term.

The asset class matters when considering mutual fund expenses. For example, you should be willing to pay more for a manager who focuses on emerging market companies than one who invests in US large companies, and less for a typical bond manager.

Explanation of Strategy

If you can’t understand what the manager’s strategy is, you shouldn’t invest with him, period. Some professionals try to confuse potential investors by developing complicated processes and criteria, things that ultimately may not add any value. While you don’t need to know everything about what they are doing, you should understand the basic framework they are using to put their funds together. Strategy, not performance, is the driver of future returns.