Co-author: TJ Ryan
It’s fair to say that the share market has been volatile over the past year.
But the market highs and lows of recent dramatic events have also created an invitation for more people to consider managed funds. This is because managed funds present the opportunity to access a diversified portfolio made up of different asset classes, industries and companies. This may reduce the overall investment risk and reduce volatility of returns on an investor’s investment portfolio as a whole.
Managed funds can be an appealing form of investment to include within a portfolio for many different investors – young investors starting their wealth accumulation journey; everyday “Mum and Dad” investors saving for the future; and seasoned investors diversifying their assets.
If you’re one of our many readers who are choosing between managed funds, here are some things you should consider when making your choice.
Before choosing an investment fund, you should know what your risk profile is. There are different funds to suit the different risk tolerance levels of investors.
Very broadly speaking, here are four common risk profiles:
- Conservative: Low risk. A conservative investor primarily seeks to minimise risk and loss of their accumulated wealth. This investor is comfortable accepting lower returns for a higher degree of stability.
- Balanced: Medium risk. A balanced investor seeks to reduce risks and enhance returns equally. This investor is willing to accept modest risks to seek higher long-term returns.
- Growth: High risk. A growth investor values higher long-term returns and is willing to accept considerable risk. This investor is comfortable and willing to endure short-term fluctuations and/or losses in exchange for the potential of higher long-term returns.
- High Growth/Aggressive: Very high risk. An aggressive investor values maximising returns and is willing to accept substantial risk. This investor may endure extensive volatility and significant losses in the hope of maximising long-term returns.
The investment strategy chosen should align to an individual’s investment objectives, risk tolerance, and investment horizon.
A multi-sector fund will often offer investment options that are labelled according to the relevant risk profile, e.g. “Balanced Fund”. However, you cannot assume that two funds with the same name offered by different companies, that all else will be equal.
Company A’s growth fund may have a great difference in asset allocation compared to Company B’s growth fund, which will impact the risk and/or returns associated with your investment in one or the other. For example, Company A’s growth fund may have an allocation of 80% towards growth assets while Company B’s growth fund has 61%.
There are many managed funds available, so it is important to choose a fund that reflects your risk tolerance, investment timeframe, and interest. Conduct in-depth research into the constructs of a fund to understand its objectives, strategy, and asset allocation so you can be comfortable with your investment.
2. Which type of managed fund?
With so many different investment funds on offer, finding the right one for you and your goals can be a lengthy and difficult process. Narrowing it down via type can help you make the right choice.
Broadly speaking, here are some examples of the different types of investment funds:
Actively managed funds
Actively managed funds are run by a fund manager who frequently buys and sells securities that they believe are going to do better than others. The fund managers aim to outperform their relevant benchmark index, but of course, this isn’t always the case.
Passively managed funds
Passively managed funds such as index funds do not require a portfolio manager to regularly trade the assets within the fund. They can simply track an index such as the S&P/ASX 200 and attempt to mimic its movements.
Ethical investment funds
Investment funds comprising of assets that complement a particular moral, health or political view are known as ethical investment (also called sustainably responsible investment). Choosing ethical investments is a growing trend, with more investors wanting to make sure their money is not funding activities that go against their personal values.
Are you worried about what companies your fund invests in on your behalf? Ethical investment funds can “screen in” companies that actively invest in sustainable activities like healthcare or green energy, and “screen out” companies that invest in tobacco.
Ethical investments can come in both actively managed and passively managed forms.
For people wanting to make returns out of falling markets, there are a number of bear funds that may be actively managed or designed to follow an index.
3. Asset class
Another thing you should consider is what asset class you want your managed fund investing in. You can choose a fund that specialises in the asset class of your choice, or you can diversify your risk by going for a multi-sector fund that invests in multiple asset classes at once.
Managed funds can invest in a variety of different asset classes, and these different assets have varying levels of risk and return.
Some examples of common managed fund investment classes are outlined below, but keep in mind that there are many different combinations of each of these:
- Shares (a.k.a. equities) such as options or shares on the Australian stock market or global stock markets
- Cash securities (a.k.a. cash management trusts) such as bank deposits, bills of exchange, promissory notes
- Property such as residential properties, industrial, retail or commercial real estate
- Fixed interest investments (a.ka. fixed income investments) such as bonds
- Agricultural or agribusiness schemes such as investment in farming, livestock, forestry
- Film schemes involving investment in movies
- Timeshare schemes involving investment in shared ownership of a property
- Mortgage schemes involving pooled money used to lend money to borrowers
Some funds only focus on a specific category within an asset class. When it comes to shares, at CANSTAR we assess funds for Australian shares and global shares separately.
4. Fees and costs
When comparing investment funds, one of the main things you should be looking at are the different fees and costs of each one. These can take a significant chunk out of any returns you might make, so thoroughly take them into account before making your choice to ensure you’re getting the best value for money.
Common fees and costs that apply to different managed funds may include:
- Buy/sell spread: This refers to the transaction cost you pay every time you buy or sell units in a fund. The buy/sell spread is the difference between the entry (buy) and exit (sell) prices of the fund. It is charged as a percentage of the value of the trade and is designed to cover costs for the fund such as brokerage and government taxes. The buy/sell spread can range from 0% to 1.23% for the funds rated by CANSTAR.
- Management expense ratio (MER): To pay for the costs of managing and operating the fund, investors are charged management fees through the fund’s management expense ratio (MER). This ratio is the percentage of the amount invested in the fund that has to go towards paying these costs each year. For managed funds rated in this year’s CANSTAR star ratings, the MER ratio ranges from 0.25% up to 2.77% depending on the type of fund.
- Performance fee: A performance fee may be charged by the fund on investment profits made through the fund. Most managed funds don’t charge a performance fee, but across the managed funds we rated for the 2017 Managed Fund Star Ratings, the most expensive performance fee is 27.5%.
- Administration fee: The administration fee is an additional ongoing fee that some funds list separately from the management fee. 10 of the managed funds we researched and rated in 2017 charge an administration fee, with the maximum fee charged being 0.46%.
- Termination fees: A fee charged for closing your account, over and above the Sell Spread. This is charged when you choose to sell your investment units and leave the managed investment pool. None of the managed funds rated by Canstar in 2017 charge a termination fee.
- Account fees: Some managed funds charge fees and costs for opening or terminating your account, such as an establishment fee, termination fee, contribution fee, and redemption fee. Within the managed funds rated by Canstar, none charge an establishment fee, and only one charges a 4% redemption fee. However, you should look out for account fees if you choose a fund not rated by Canstar.
Our Managed Fund Star Ratings take into account the costs involved in investing in a managed fund:
5. Withdrawal process
When investing, it’s always important to have an exit strategy in mind. You don’t want your funds frozen in an investment that you’re no longer happy with – especially if it’s plunging in value.
As such, you need to fully understand the withdrawal process of the investment funds you’re considering before making the decision to invest your money.
Unlisted funds can be ‘frozen’ to withdrawal requests when a lot of investors choose to withdraw around the same time such as in periods of significant downturn. This is because some funds do not have enough cash available, since most of the funds might be in assets such as property and shares. During these times, the fund might provide other ways to withdraw such as through withdrawal offers and hardship relief.
6. Long-term performance
Past performance is no indication of future performance and you should not rely on this as your sole reason for choosing a managed fund. A fund can achieve over 20% growth in one year, and then suffer losses in the next. However, the long-term performance of a fund is worth considering. After all, achieving growth is the whole point of investing.
7. Other features, terms and conditions
Some of the features that CANSTAR assesses in determining our star ratings include things such as:
- Product Conditions: Minimum investment required; minimum additional investments; minimum withdrawal amount; availability of regular investment plan; availability of different payment methods.
- Investor Access: Online or phone access to check balance, statements, or update personal details; ability to make buy and sell requests online or by phone; ability to check fund performance online; availability of call centre for support.
- Distributions: Frequency of fund distributions (weekly, monthly, quarterly); availability of reinvestment plan.
- Fees and Rebates: Number of free switches per year; switching fee; termination fees; performance fees; availability of fee rebates or discounts.
Compare managed funds on our website: