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Welcome to the final episode in this four-part podcast from Bennelong Funds Management. Today we will be speaking with Stuart Fechner, Account Director of Research Relationships about the characteristics of a good investment fund.
Stuart, how do you identify a good fund?
There are lots of different ingredients or factors that can be assessed and then classified into different criteria or categories.
I think in approaching things this way, it also makes it somewhat easier to then compare or contrast one fund with another.
What sort of criteria come to mind?
Firstly, in a broad sense there is the overarching business or organisation itself. Then there are the more fund-specific factors such as the investment team and their related investment process.
The organisation or business side is important – if the company doesn’t exist or isn’t profitable, the long-term life of the fund itself could be in question.
Equally, if the business doesn’t have the appropriate resources and skill sets to adequately fulfil the legal, compliance and administrative functions that are needed in operating the fund, then again the longevity and compliant nature of the fund may be in question.
So on the investment side, what sorts of things are important to assess?
I tend to cluster different items into four categories or functions that are important in managing and offering a fund:
- The investment team
- The investment process and stock selection
- Portfolio construction
Can you explain a bit more about each of these?
In terms of the investment team, it’s things like:
- Their experience:
- How long they have been managing money
- What particular investment strategies or approaches they are managing today
- Their track record:
- Have they been managing money for a long time
- Have they shown and illustrated that they are good at it and have the capacity and insights to add value
- Team size and depth:
- How large the team is (It doesn’t necessarily mean the larger the team size the better it is)
- Do they have the appropriate resources within the team to be able to implement the investment process at hand – some approaches are more resource intensive than others
- Does the team have good stability – ideally you want a good level of continuity and cohesiveness amongst team members
What about the investment process? This sounds like something that’s central in managing a fund.
The investment process is really ‘doing the doing’ in terms of identifying and selecting investments or shares for an equity fund for possible inclusion in the final portfolio.
Assessing an investment process includes starting at the very start and trying to understand where a team’s investment ideas come from. Is it purely from their own thoughts and ideas, or do other factors come into play? There can be a whole range of these, including broker research and insights, industry conferences, economic related readings and company and industry related meetings.
Next, you can look at how the detailed company research is conducted and by whom. That is, are the various members of the investment team specialists, who focus their knowledge and efforts on particular sectors or stocks? Or do they take more of a generalist approach and cover a range of different sectors and stocks?
It’s also important to then understand the screening process – that is, what screens or rules are applied to the full range of stocks that are available (e.g. if we’re assessing the process in relation to an Australian share fund). Screens for quality, as an example, might include ‘screening out’ companies who are felt to have too much debt on their balance sheet and/or not a high enough level of interest cover.
What is effectively being looked at and assessed in this area is what range and level of screening is conducted and how rigorously and consistently it is applied. For example, in terms of consistency is there a standard template and set of criteria than every analyst must utilise and assess, or are they free to apply and operate whatever approach they individually feel is best?
The level of rigour and consistency is probably the key factor across the whole investment process that I see as most important, and goes a long way to understanding the level of repeatability that can be achieved and implemented.
If consistency doesn’t exist, it’s pretty hard to get a handle with any level of real trust or comfort on what the manager is doing and hence what outcome, or at least investment characteristics, the fund may then provide.
The final point in this area is what range of type of stocks are available for possible inclusion into the portfolio. Is there a defined ranking or pecking order of these stocks, or perhaps another type of scoring or categorisation process conducted?
Once all the stock and company assessments are done, how do you evaluate the final portfolio?
Good question. The stock research and portfolio construction are of course related, but at the same time are very different roles and require different skill sets.
It’s a really important role and function to assess. After all the hard work of the stock research has been done, it’s important to then understand and determine how the best stock ideas make their way into the final portfolio.
It may be easy enough to say or identify that you want certain stocks in the final portfolio, but at what weighting? Ideally you would expect to have the stocks with the stronger level of conviction having a higher weighting within the portfolio, but how does this process work?
Here it’s not just how in terms of seeking to achieve the best possible return, but also importantly, how the assessment of managing risk within the final portfolio is conducted.
The assessment of managing risk sounds important. What does that entail?
It’s understanding what procedures or measures are in place to firstly identify and then manage risk within the final portfolio. It’s not a good outcome for a portfolio to perform poorly due to an unknown factor or event that hadn’t been identified – let alone assessed.
For a fund manager, this involves identifying and understanding what the potential risks are and what impact they may have on the portfolio should they play out. Such a risk could be, for example, a sharp and unexpected rise in interest rates.
And ultimately, why is this so important?
Each fund or related investment strategy tends to have a particular investment style or approach.
Certain styles – and hence funds – tend to have different characteristics of how they typically perform in different market conditions. That could be in a strongly performing market or a weaker and possibly negative market environment.
When a fund’s investment strategy and approach is implemented on a consistent and repeatable basis, it provides a greater level of comfort and predictability as to how a fund may perform under certain market conditions.
This effectively relates to the saying of a fund being ‘true to label’. That is, it provides for investors what it says it will on the label. A fund being ‘true to label’ makes it much easier for an investor to then identify and select a fund to play a particular role or purpose within their overall portfolio – again that saying of ‘funds for a purpose’.
Is the fee associated with a fund included in this type of assessment?
Yes, the fee level is certainly something that’s assessed. And I don’t think it’s as simple as saying the lower the fee the better – but fees do need to be taken into account and understood when assessing or comparing funds.
It’s really about assessing if the fee level associated with a fund is at a reasonable and appropriate level for the type of fund that it is.
At the end of the day, when net returns are looked at (that is the return the fund provides after taking fees into account) it can easily be seen if the fund has delivered value for money.
There’s a lot that goes into assessing a fund – do you have any final comments on this?
At the end of the day, it’s about trying to gain a level of comfort that a fund can and will perform well and meet its stated investment objective.
While there is no guarantee that a fund will perform well or better than another fund, a level of comfort comes from reviewing and assessing many elements of a fund (including those we’ve discussed).
All in all, if a fund is assessed quite strongly in each of these elements, it may provide a greater level of comfort that it has a good opportunity to meet its stated objectives.
Well, that brings us to the end of today’s episode, which was the final one of the series. We hope you enjoyed this podcast, and encourage you to visit bennelongfunds.com for more insights from the team.
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