Entrepreneurs Up2Date - The wonderful world of equity funds
The wonderful world of equity funds
Selecting stocks is a full-time profession: thousands of companies report figures and updates on a regular basis. For a good portfolio, a selection must be made based on quality, diversification, valuation, risks, etc. Of course, making that exercise once is not enough: all companies in the portfolio must also be monitored, in order to weigh the companies' underlying performance against their ever-changing stock price.
It is ideally the same for companies that are not in the portfolio. Because what wasn't an interesting entry point yesterday may suddenly be tomorrow. In short: compiling and managing a stock portfolio is an exciting, but actually also a full-time activity, which also requires the necessary knowledge, experience and discipline. That's why many investors choose not to select a basket of stocks themselves and follow them up on a daily basis. They let an expert do this, for example by purchasing an equity fund.
So how do you select the right funds?
There are now more funds than stocks, so in a way, the problem is changing. Nevertheless, as far as the initial selection is concerned. Once selected, it is often enough to check occasionally whether management and performance are in line with expectations. Then you no longer have to follow the daily news flow.
The question remains how best to make the initial selection: which fund (s) are worth buying?
A lot depends on the investor's potential preference. About his expectations, affinity and risk profile. In what follows, a number of topics are discussed that can be used as a guide.
Active versus Passive?
One of the first decisions to make is whether the investor wants to invest in an actively managed fund or a passive index fund, also known as an “Exchange Traded Fund” or ETF for short.
In an actively managed fund, the fund manager makes a selection of stocks that, in his or her opinion, should perform better than the market as a whole. In addition, price movements are actively used to buy or sell certain positions in an attempt to earn an extra return.
With a passive fund, the investor buys 'the entire index'. The selection is then not done by the manager but outsourced to the index provider's formulas, often MSCI or S&P. In most cases, such indices are “market capitalization weighted”. This means that more money is invested in large companies and less in small ones: twice as much will also be invested in a company that is twice as big. Regardless of the company's valuation ratios or future profit expectations. Index investors assume that the market is efficiently priced and save themselves the trouble of forming their own vision about a stock. The advantage of a passive fund is that management costs are generally lower: no one monitors the selection of the purchased shares and there are few or no transactions. The management fee can therefore be kept to a minimum. On the other hand, as an investor, you will never do better than “the market” as a whole. Something that an actively managed fund does strive for.
Diversification: regions and sectors
A second choice to make is which regions to invest in. Is the focus on investing globally, or do you prefer to only buy European stocks? Do you want to try your luck in emerging markets in Asia or can part of the portfolio, with a hint of chauvinism, be allocated to a fund that invests exclusively in Belgian stocks?
The advantage of investing globally is, of course, the spread. By investing widely, specific risks are the most diversified away. The disadvantage is that some more currency risks are taken, and geopolitical tensions can have a somewhat larger impact than with a portfolio that only invests in the Western world. Such risks are further exacerbated when investing in emerging markets. Internal politics and regime changes can have a significant impact on returns there. On the other hand, a number of regions show slightly more growth than Europe or the US. Investments closer to home, on the other hand, have the advantage that they are closely followed up in the local press, and are therefore generally better known.
The same reasoning can be made when it comes to sectors. Do you prefer a specific sector or a diversified investment solution?
Complementarity
When compiling a fund portfolio, it is important to pay attention to overlaps. There is little point in combining a global ETF with an actively managed global fund that follows this index fairly closely. The top 20 positions will then be very similar and will add little diversification to a portfolio. Interesting ratios for keeping this context in mind are the so-called “tracking error” and/or “active share”. The tracking error measures the volatility of the return differential between a fund and the benchmark index. The higher this number, the more actively the fund is managed and the greater the deviation from the reference index may be. The “activeshare” measures the sum of the deviations at the level of the portfolio's weights. It is generally assumed that a number above 60 is acceptable, while funds with an “active share” of 90 or higher clearly stick their necks out and have strong opinions.
In addition to the return, the extent to which a fund is actively managed provides an important indication of whether a manager is worth its higher management costs. High-cost funds, whose allocation differs very little from its reference index, are therefore avoidable.
Costs
Be sure to also view and compare the costs and, first of all, the management costs. This is the annual percentage that is charged for managing the fund. However, management fees are not the only costs associated with investment products. In many cases, an entry fee and sometimes a performance fee are due. In that context, it is certainly useful to compare the cost structure closely. The Belgian regulator, FSMA, published a good manual on this subject that maps out all cost aspects. https://www.fsma.be/nl/news/fsma-studie-over-de-kosten-verbonden-aan-beleggingen-fondsen
Who manages the fund?
Of course, you want to know the reputation of the fund house you trust your money to. And even more: who is the manager of the fund exactly? We are not talking about the sales manager, but about the person who is effectively at the controls and does the daily management. Is that someone with years of experience, or can you expect more youthful enthusiasm? And how long has the fund been managed by the same person? For funds where someone else takes care of the management every year, you may wonder whether there is sufficient continuity and whether there will be no unnecessary transaction costs for each manager change to implement a new vision. It may also be interesting to know whether that manager is also responsible for other funds. If the same person manages 5 other funds in addition to your fund, you may wonder whether enough attention is being paid to monitor the shares in your fund.
Finally, the communication of the fund house is also a point of attention. Is there openness and transparency about what is happening in the fund and why, or is communication limited to the legally required minimum? Is there also communication in more difficult times or does the manager suddenly not give home in the event of a stock market crash?
Historic returns
We end by kicking the cash: what were the historic returns of the fund you want to invest in? This is often the first — and sometimes only — thing that potential investors pay attention to. And while past performance is never a guarantee of future performance, past performance may, in a sense, be...
Simply sorting all available funds by yield and picking out the best ones is somewhat short of a curve. How much risk was taken to achieve that return? What is the average valuation of the companies in the portfolio, and how many transactions have occurred recently? If the fund has invested in undervalued stocks in the past, but they have now become expensive and are still in the portfolio, you are now buying a fund with a good historical return, but you are investing in expensive valuations. Meanwhile, if profits were taken and overvalued stocks were replaced by undervalued stocks, it's a completely different story.
Practical: Fundraisers & Screens
Do you want to find a fund that suits you? Then there are online help tools such as fund seekers or fund screens, where you can find the suitable fund based on various criteria. It is therefore advisable to opt for independent tools, which are separate from banks or financial institutions that offer investment services.
Two interesting tools are the Time Fund Finder and Morningstar's.
Under Time, you can specify the Time ratings (the Crowns), you can choose sustainability, choose the administrator, sector, region, currency, benefit type, category and, last but not least, the risk in the form of the SRI index. The Summary Risk Indicator is a measure that ranges from 1 to 7. The higher the number, the higher the risk (as well as the potential return). https://www.tijd.be/markten-live/fondsen/search.html
At Morningstar, you can choose from the following filters: Fund House, various Morningstar Ratings, Category, management style, and ongoing costs. https://www.morningstar.be/be/funds/default.aspx
At Morningstar, you can take a quick look at many parameters for each fund, under the heading “Data Quickview”. Here you can see the returns of the past 5 years, divided by year, as well as quarterly returns. At least as interesting as the returns are the risk measures. In the Style Box, you can also see how much the fund invests in big caps and small caps and what investment style (Value/Growth) the fund uses in its management.
We wish you the best of luck! And are also at your disposal for any advice.
