Many investors aiming to beat the market outsource stock purchase decisions to professional fund managers. Immediately they encounter the confusing universe of collective investments, which includes more than 4,500 open fundsmore nearly 400 mutual funds. There is simply too much choice.
Aside from paying for investment advice, how can investors assess whether the professional managing the fund or investment trust is any good? Enter the ratings industry, employing analysts who rate funds and rely on a variety of criteria.
Some rating companies limit the results of their analyzes to professional advisors. If you use a consultant, ask to see the ratings they use. But if you don’t, three respected and long-standing companies, Morningstar, FE, and Refinitiv Lipper, offer free public assessments. And this week Morningstar updated its fund ratings to make them easier to use.
Their work is independent – fund managers don’t pay for rankings – and when you don’t have time to do your own analysis, it’s worth checking out.
For example, Morningstar downgraded its rating on Neil Woodford’s flagship Equity Income Fund from from bronze to neutral in May 2019. This was the month before the fund closed to investors after Woodford’s holdings in private and illiquid companies prevented him from selling assets quickly enough to meet client withdrawal requests. While Morningstar wasn’t shouting “sell this,” for such a popular fund to have a low rating was a wake-up call.
Using the rankings of these companies is definitely not foolproof. Analysts are human and make mistakes when accounting for everything from manager records, fund costs, trading frequency and relationship with the manager.
Quantitative performance research seems more scientific, as analysts study tangible financial information. This could be the fund’s performance story, compared to the performance of a chosen benchmark. Analysts could also look at the consistency of performance and compare the record during market highs and lows. The disadvantage of quantitative research is that it looks backwards and, as the financial regulator likes to say, when it comes to investment performance, the past is no guide to the future.
Qualitative research aims to look forward, but is more subjective. This covers aspects that are difficult to measure, such as the quality of the fund manager and his team. It often involves lengthy meetings with the fund management company to talk to staff and learn about their investment philosophy. You rely on the analyst’s experience and his ability to shield his own prejudices. You might even trust their instincts to some extent.
Research and analysis of funds and fund managers can be quantitative, qualitative or mixed.
THE FE fundinfo Crown Ratings help investors distinguish between funds that clearly outperform their benchmarks and those that don’t. The top 10% of funds receive five kroner FE fundinfo, while the next 15% receive four kroner. However, FE fundinfo cautions its Crown Ratings that they are “purely quantitative and look to the past and, as such, cannot offer any certainty about the future”.
In April Refinitiv Lipper released the winners of its annual fund awards. Premiums are useful for finding funds with consistent performance.
Morningstar this week combined its quantitative and qualitative analyst research into a new scoring system to make it easier to navigate. The Medalist Rating has a simple scale of Gold, Silver, Bronze, Neutral and Negative.
Morningstar has a universe of 66,365 in its fund screening tool. Of these, 2,668 have top gold. If you add Morningstar’s previous star ratings, which are a purely quantitative, retrospective measure of a fund’s past performance, and pick only the funds with the top five stars, you’re left with 397. It took me less than a minute to the Morningstar site.
And now the separate thorny issue of ESG ratings, which aim to help investors evaluate portfolios on environmental, social and governance factors but have often been criticized for a lack of shared and transparent methodologies.
The Morningstar Sustainability Rating is worth checking out – after several iterations since 2016, it has evolved into a measure of financially relevant ESG risks in a fund.
However, sustainable investors who select the top five-globe Morningstar Sustainable Rating score, in addition to Morningstar’s other top ratings, are left with a very limited selection of 40 funds from a handful of managers.
Your alternative is Fund EcoMarket, which offers information on investment funds that pay particular attention to sustainable, responsible, ethical or ESG (environmental, social and governance) issues. The database, managed by SRI Services consultants, is open to all and is currently being updated. However, it’s designed for professionals, so be prepared to do your homework. The screening begins with a choice of nine investment styles and is followed by hundreds of multiple filters on underlying issues and policies.
If that seems like too much, check out the recommended listings from leading investment platforms. Hargreaves Lansdown has responsible funds in its Wealth Shortlist, while AJ Bell includes responsible funds in its list of preferred funds. Interactive Investor takes it one step further with the ACE 40, a list of sustainable investing ideas.
So now you have some tools, use them to review your fund holdings once or twice a year. And if you find a rating going down or a fund falling off a list, the universe of 5,000 collective investments means there’s always an alternative.
Moira O’Neill is a freelance writer on money and investing. Chirping: @MoiraONeillInstagram @MoiraOnMoneye-mail: moira.o’neill@ft.com
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