Quality is an elusive concept. But with so many actively managed funds competing for your investment dollars, it’s an important one to understand because the success of your fund portfolio depends on it. Widely agreed on components include low costs, consistent long-term performance, distinct investment philosophy and tax efficiency.
But nine investment advisers I surveyed had other guidance on this important subject.Dan Sondhelm, partner and vice president, SunStar Strategic, Alexandria, Va.
“Strong attributes include:
• An investment process that you understand. It’s tough for investors to understand a black-box strategy where the portfolio manager doesn’t share the secret sauce.
• A fund that communicates with investors more than the required semiannual report.
• A portfolio manager who doesn’t hide and tells you what he is doing to manage the portfolio.
• Consistent performance: Results should be consistent with what it says it will do.
• Above-average performance for short and long term.
• Low expenses: approximately 1 percent or less.”Matthew Tuttle, CFP, president, Tuttle Wealth Management, Stamford, Conn.
“A high-quality fund is one that is managed by a ‘skill-based’ money manager as opposed to a ‘style-box-based’ money manager. A style-box manager tries to match and slightly outperform an index, but over the long-term he usually doesn’t. A skill-based manager can go anywhere and invest in anything. If they’re any good, they’re worth paying for.”Mike Saghy, director of investments, PNC Bank, Pittsburgh
“In reality, high-quality, actively managed funds are funds that stick to their discipline. That means both from the taxable standpoint of executing trades based on their quantitative analysis as well as their qualitative overlay, but also based on maintaining their disciplined approach to whatever style sector concentration or other theme they have depicted in their original outline of the fund.
“Unfortunately, over time based on the volatility of markets — especially the last 18 months — a lot of mutual fund managers have deviated from their discipline. They get into what we commonly refer to as scope creep outside of their stated objectives. A value manager might go toward growth, and vice versa.
“Individual investors who have a lot of mutual funds that they manage themselves run into a problem that leads to increased risk with overlapping positions, higher concentrations and having the same security within multiple funds. That leads to more risk and more volatility than even what the active market or index market might have.”Christine Moriarty, CFP, financial educator and president, MoneyPeace, Bristol, Vt.
“The fund invests in what it says it does. Many managers jump on the next great trend to get returns for their fund. When picking a fund, an investor needs to take into consideration their goals and strategy. If the fund isn’t consistent, it can cause havoc on their investment strategy. A fund’s returns also matter, although that shouldn’t be the main decision-making point. One year of good returns is history. The future is what matters.”Chad Olivier, CFP, Olivier Group, Baton Rouge, La.
“When someone looks toward actively managed mutual funds instead of index funds for investing purposes, there are many things to look at. It’s important not to invest totally in one fund family.
“If you invest all your money in American Funds, Vanguard, Hancock, PIMCO, etc., you could have considerable overlap in certain positions. You’ll have too many of your eggs in one basket and can take excessive losses when you initially think you’re diversified. Instead, spread out your investments. This will ensure that you have different investment professionals choosing the investments instead of the chief investment officer at one of these families.
“You want to look at how the fund has reacted and performed in both bull and bear markets. If a fund has historically performed very well in bull markets but has been awful in bear markets, you might want to look at a fund with less volatility. The less volatile the return of the investment, the better the scenario for the investors. These returns also indicate that the managers have a good idea of the leading indicators of the market and can typically judge its direction and plan accordingly to create higher returns.”Michael Edesess, partner and chief investment officer, Fair Advisors, Denver
“There’s no way to separate high-quality actively managed mutual funds from other actively managed mutual funds except by using two criteria: costs and tax efficiency. No statistical methodology can discern, with any meaningful level of confidence, whether one actively managed mutual fund is more likely than another to outperform its benchmark in the future.
“The higher-quality funds — in the sense that statistical and scientific analysis can show that they’ll be more likely than other funds to deliver better results to the investor — are the ones that minimize fees and taxes. That is the simple and plain truth.”Gary Hager, CFP, president, Integrated Wealth Management, Edison, N.J.
“I look at a handful of items that will qualify or disqualify a fund. If it’s an active fund and basically has an essential theme, I look for an exchange-traded fund that I can potentially compare performance to, both the risk-adjusted performance and the volatility. The next thing I’m going to look at is manager and tenure. In this day and age, it’s more difficult to manage, especially with the financial crisis, so my preference is to have a fund that’s managed by an individual who has been around no less than 10 years.
“I don’t want any hybrid funds. A fund to me can’t be a blend of any kind — it’s got to have one discipline, whether it’s a large-cap growth fund or a small-cap value one. Show me a manager who has expertise in one area. I don’t really believe you can have expertise in more than one.
“The next thing we’re looking for is the fund family itself. We want to know that the fund has strong backing from a company that has been around for a long time. We also like to look at expenses compared to a peer group.
“And be careful about reaching for funds that are ranked No. 1 in a particular year because more often than not, No. 1 becomes No. 10. It’s better to look for a sustained effort over time.”
Manisha Thakor, CFA, former analyst and portfolio manager, Santa Fe, N.M.
“My top five attributes that separate the many mediocre mutual funds from the handful of really good ones are:
• low fees
• low portfolio turnover
• 50 or fewer holdings
• long-tenured investment team
• employee-owned firm”Michael G. Knox, CFA, president, Xtract Research, Ridgefield, Conn.
“I think the real question is whether one should choose an actively managed fund over an index fund once a decision has been made to allocate money to equities. Here are some things I would consider:
“How many stocks does the manager own? If they own 300 stocks, then what’s the point of paying the management fee? Just buy an index fund and pay a lot lower fees. You’re paying a manager for their expertise and stock-picking ability. Anyone with a larger number of holdings isn’t really providing that value. Fewer positions create more risk if the manager is wrong, so be prepared for that result and don’t put all your eggs in one basket. I would discard most managers with more than 100 holdings in favor of an index.
“Read a manager’s comments in their annual reports and look for insightful comments. Talking about Microsoft’s sales growth or some other item that everyone knows doesn’t show a lot of depth in the thought process. Look for something interesting that demonstrates that a lot of research has been performed.
“Look for comments about debt in the annual report. Equity managers who don’t understand the debt market and the implications for rolling over bank debt or other maturing debt are taking the risk of getting burned by things they don’t understand. In this environment, you want a manger who understands the entire capital structure.”