You design your own share portfolio of handpicked stocks so why would you entertain the idea of a managed fund?
Well, put simply, because there are times when even hardened share enthusiasts simply can’t get stock selection right and can benefit from the wisdom, insight, experience and contacts of a fund manger.
Pooling your money with other investors through a managed fund enables diversification into assets, markets or sectors that you simply can’t access by going it alone. You think India or China is the next booming market to invest and are eager to get in on the action. But how do you buy stocks in India or China?
Managed funds issue units that represent each individual investor’s share in a range of investments selected by the fund manager. The price of these units rise and fall according to the value of the investments.
Phillip Gray, editorial and communications manager with research house Morningstar says he encourages investors to consider managed funds because “much of the time investors think they have a diversified share portfolio when all they have is, for example, a series of financial stocks”.
“A lot of studies have shown that people’s portfolios are much less diversified than they think they are,” says Gray “and a fund manger is a disciplined professional whose job it is to construct portfolios that have the correct kind of diversification.
“As well they often have a risk budget, which permits them to allocate a budget spread across a wide range of investments in order to achieve the most desirable risk/return combination.”
True, all investments bear an element of risk and managed funds are certainly not exempt from this. The risks of investing in managed funds hinges on the type of managed fund in question – whether it mostly invests in shares, property, fixed interest or cash, or a combination of different asset classes – and the expertise of the fund manager. But Gray contends that the broad spread of companies and the greater diversification possible in managed funds should make them less risky than the majority of individual share portfolios.
This is especially true of a share portfolio filled to the brim with smaller company stocks, a risk that many investors face as we sit in the midst of a resources boom. Indeed, many investors have probably bought into the smaller end of the market as up-and-coming miners have caught the attention of the media and share punters alike.
“There is an argument that says it’s easier for a fund manager to add value by investing in smaller companies or what’s termed the ‘inefficient market’ sector,” says Gray.
This is doubly true of international companies such as buying shares domiciled in the US, Europe or the increasingly popular BRIC (Brazil, Russia, India and China) regions. Imagine the difficulty of buying Brazil’s state-run oil and gas firm, Petrobras, or the fast-growing personal computer manufacturer, Apple, which trades on the NASDAQ.
International shares also attract additional political and social risks, regulatory restrictions, market liquidity issues, not to mention currency risk. For instance, an appreciating Australian dollar against the respective currency can all but wipe out a successful international share purchase. (On the flipside a depreciating Australian dollar versus the currency in question can turn a good investment into a bonanza).
Getting stock selection right on the international arena therefore involves plenty of research, good timing and a penchant for risk. Recruiting a fund manager to do the dirty work for you is often the best solution.
However, fund managers aren’t guaranteed to get it right all of the time either. Take emerging markets as an example: tempted by potentially explosive returns on stocks in stgeloping markets, fund managers and investors are increasingly keen to spice up a share portfolio with an emerging-stock flavour.
The far majority of international share funds offered to Australian investors concentrate primarily on stocks from the major stgeloped economies, such as the United States, the United Kingdom, Japan, and the European nations. However, increasingly, emerging markets are sought out by both investors seeking extra alpha, and fund managers seeking funds under management.
“Everyone wants to jump on board the strong growth that we’re seeing out of places like India and China but many emerging markets are still unstable, have governments that don’t have the same respect for property rights as we do in Australia, don’t possess established standards for reports, accounting and company financials and are prone to military coups,” says Gray. Gray recommends sticking to diversified international share funds that invest primarily in the more well known and liquid stocks. Liquidity is an important issue, notes Gray. “If a stock is illiquid it can be hard to find a buyer if you want to sell”.
Investors certainly won’t struggle locating managed funds to buy. Almost every conceivable kind of investment opportunity can be packaged up in the form of a managed fund. Morningstar, for instance, has about 50 different categories of funds and within each category exists hundreds of funds. But most money in Australia tends to be invested in domestic shares, international share funds and balanced or multi-sector funds, which are funds that invest in a range of different asset classes.
Narrowing down your selection is the tricky bit. How to find the right fund manager is what Gray refers to as “the sixty million dollar question”.
“Each fund manager has a specific approach to and style of investing,” he says. Most investors buy managed funds through a financial adviser.