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10 tactics when researching funds, investment trusts and ETFs · On The Money

• 0:03
  Kyle Caldwell: Hello, and welcome to On The Money, a weekly look how to get the best out of your savings and investments. In this episode, Sam Benstead is making his final appearance on the podcast before he heads off to pastures new. And as it is his final appearance, I was keen to extract for you as much of his funds, investment trust, and ETF knowledge as possible. And this is why we've devoted this episode to explaining our top tactics for what to look out for when researching collective investments. So Sam and myself are gonna cover five pointers that we've separately come up with, and we're gonna start off with funds charges.
• 0:45
  Now, of course, when it comes to investing, there are no guarantees of a set level of performance, and indeed, there are no guarantees that you'll make a positive return. Although the history books do indeed show that if you invest for the long term of at least five years, ideally much longer than that, then going down the stock market route tends to grow your wealth more in real terms as opposed to leaving your money in cash. While cash is, of course, safer, its Achilles heel is the cash tends to not keep up with inflation over the long term. However, Sam, one thing investors can control is costs, and this is why it's very important to have a look at fund charges in respect of both active funds, those managed by professional investors, and index funds and ETFs, which passively track the up and down fortunes of a particular index. So, Sam, I'll hand it over to you to explain the importance of looking at fund fees.
• 1:44
  Sam Benstead: Thanks, Kyle. So as you say, cost is one of the main things that we that we definitely can control. And I think when investors look at index funds, cost is especially important because often you might have two comparable products tracking the same index, and the only thing that really separates them is the cost. So there's two big index fund providers, BlackRock and Vanguard, and BlackRock's index fund group is the iShares division. And I think a lot of people are drawn to these two fund managers for their passive options just because they are the largest.
• 2:16
  And while they are brilliant fund managers, and they've been doing this a long time, there are some alternatives to tracking some of the biggest stock market indices that I think are worth considering. So I'll just highlight a few here, and we've seen these all, be very popular in our monthly most bought lists as well. So the HSBC FTSE All World Index is very popular. This tracks global shares including emerging markets for a low fee of just 0.13%. For The US market, the SPDR S and P five hundred ETF, stock market ticker SPX five, which is part of our super 60 list, charges just 0.03% for American shares, and that compares to 0.07% for the alternative from BlackRock and Vanguard.
• 3:06
  So very, very competitive there and vetted by our expert fund research team. For the MSCI World, you can pay just 0.12% with Fidelity index world, and that's an open ended fund. If you wanted an ETF, you can pay the same fee for the SPDR MSCI World ETF with the ticker SWLD. So some great passive options there if you are very cost conscious. For active funds, a higher fee doesn't mean a better fund manager.
• 3:36
  And, actually, often the best fund managers are actually backed by great fund management firms, and they work really hard to keep fees low for investors. So three investment trusts really jump out to me for their low fees, but also excellent management, and those are Scottish Mortgage, City of London, and Capital Gearing. So very experienced fund managers there, great long term records, and those fees respectively are 0.35, 0.37, and 0.56%. So really, really good fees and great long term performance. Whereas from other active funds, if you're looking at fees above 1%, I think you've really gotta figure out why want to back that fund manager.
• 4:18
  Kyle Caldwell: And as Sam has explained, with fund charges, it's really important to look for like for like. So if it's an index fund or an ETF, compare that index fund or ETF against others that are tracking the same market. And in the case of active funds, it's a case of looking at the sector or region that the fund is investing in and then compare charges against competitors to see whether fees are lower, whether they're about average, or they are higher than average. In terms of what is the typical fund charge, for an index fund or an ETF tracking, say, the S and P 500 index or the Footsie all share, so a mainstream developed market, you can pay less than naught point 1% a year as Sam outlines. For an actively managed funds, so for an an equity fund that's investing globally or in The UK or in Europe or in The US, typically, the charge per year is gonna be around naught point 8% to 1%, and it's what is known as the ongoing fund charge.
• 5:27
  For me, it's easy to overlook costs, especially when they are quoted as a percentage, But even a relatively small percentage difference can make a big difference in pounds and pence over the long term. While a few percentage points of fees may not seem much over one year, over twenty or thirty years, they can seriously reduce your net worth if you're not getting a better outcome, if you're not getting outperformance of an index. For me, there's nothing wrong with paying a premium or paying more for an active fund, but you want to see that performance delivered and add value for you over the long term. We're now gonna move on to the second item in our agenda, which is to look under the bonus. So in terms of looking at the bonus, I think it's important for investors to find out how a fund invests, take a look at its top 10 holdings, compare those holdings with the index, have a look at how the funds has performed versus a compatible index over different time periods over one, three, five years.
• 6:30
  Now if you notice that the performance line of the funds is quite similar to the index, this could be a sign that the full manager is not taking enough active bets. It's not investing differently enough from the index. Now one metric that some fund firms publish is what is known as the active share ratio. Now, unfortunately, it's not widely available and fund firms are not mandated to publish this ratio on their fund fact sheets or on other marketing literature. But it's a very useful ratio when it is published to show how active the fund is.
• 7:08
  So if a fund has an active share ratio of over 80%, that tends to show that the full manager is investing very differently from the index. If I'm being cynical, if a fund fame is not showing the act the active share ratio, then I'd potentially question why is that the case, and is the funds being active enough? So we've already spoken a lot about active funds versus passive funds, index funds, ETFs. And we're now gonna come on to our fair tactic, which is to mix and match between the two fund types. Now for me, I think some people are far too dogmatic in taking one side over the other.
• 7:51
  And, of course, there are a lot of vested interests on both sides of the arguments about whether to entrust a full manager or to whether simply own the market for an index fund or an ETF. But for me, it shouldn't be an either or decision. They can both work well alongside each other in a portfolio. Sam, over to you to explain how blends and the two approaches can give investors the best of both worlds.
• 8:14
  Sam Benstead: Yeah. I think that's the right way of looking at it. There's no reason to just select passive or just select active. And, actually, in my personal portfolio, I've got a mixture of active and passive funds. As a broad point, I say passive funds are great at capturing a market, and if you want exposure to global shares or US shares or UK shares, the simplest thing to do is just own passive, and most of the research in most markets points to passive funds outperforming active funds over the longer term.
• 8:43
  That's not to say that active funds won't outperform, but generally, you've got a better chance of winning in the stock market with a passive fund than trying to select one of very many active funds. Not to say you can't do it, but the odds are probably in your favor if you go with a passive fund. But actually, if you look at the way passive funds are made up in the main markets at the moment, you'll see that they're quite concentrated in US shares. So the global MSCI World Index is about 73% in US shares. Eight of the largest US companies are now in the tech sector.
• 9:18
  So it really is looking more and more like a bet on The US and the tech sector, specifically if you own a passive fund. And that's been a great winning thing for markets over the past fifteen, twenty years, but it does contain some hidden risk. So, actually, one way of thinking about the active passive combination is to balance your passive funds, which are quite tech heavy with an active fund, which actively seeks to own cheap shares, for example. So a global tracker fund, but the value funds, also looking at global shares could be a really neat combination.
• 9:55
  Kyle Caldwell: And as well as costs with index funds or ETFs, it's also important to look under the bonnet and check out which index the fund is aiming to replicate. So for example, there are a number of global equity income ETFs that track various different in indices. And because of this, the the difference in performance can be quite stark. We I last wrote about this around a year to eighteen months ago, and I was really surprised to see how wide the gap was between the best performer and the worst performer over over three and five year time periods. And the reason why is because some some of these global equity ETFs follow the up and down fortunes of a basket of shares that are filtered based on a certain level of dividend yields.
• 10:44
  Some of them focus on dividend track records, so companies that have grown their dividends consistently over a certain number of years. For example, over six, seven, eight years or more. And some ETF providers use indices. So they so when I say indices, it's a selection of different companies that have been screened for different criteria. Some of them use indices that they've actually built themselves.
• 11:11
  So it's really important to look under the bonus with index funds and ETFs as well as the fund fee, check out which particular part of the market is attracting, and and then make an assessment on whether you want to gain exposure to that area or those particular group of companies. However, when it comes to research and funds, I think it is fair to say that it is simpler to buy an index fund or an ETF. If you buy in an actively managed funds, there's a lot more other factors that you need to consider. And number four on our list is to consider how long the full manager has been running money for. Like anything in life, experience counts for a lot.
• 11:56
  So full managers that have been around the block a couple of times, they will have witnessed a number of market cycles, and they'll be able to draw it on their experience, including learning from any past mistakes. Now, of course, a newcomer, so a full manager that's been running money for a couple of years, they could come in and do a great job. And in the case of younger full managers, they'll have not just come in and be completely new. They'll have several years experience as an analyst prior to making the step up to run money. And in addition, there is much more of a team approach nowadays.
• 12:34
  Long gone are the days of the staff or manager culture. Although, I do think, particularly for retail investors, it's very important that there is a key decision maker and that there's credibility and there's accountability and that there is a key figureheads that explains the reasons why performance is not to scratch if the funds is having a bad spell of performance. However, do also bear in mind with experience for managers that the past, of course, is not always prologue, and there have been cases where veteran for managers have had the best years of performance at the start of their careers when they've been running less money, which means that they can be more nimble and move in and out of stocks quicker.
• 13:18
  Sam Benstead: And they might have had a lot of success at the start of their careers, and actually, ten, fifteen, twenty, thirty years later, markets have just fundamentally changed. And the way they want to manage money and the way they were brought up doing it just doesn't work so well anymore, and they haven't been able to adapt to new market environments.
• 13:36
  Kyle Caldwell: And one final point for me actually, Sam, is the it is the reassurance to see a full manager in the same post for a long period of time of, say, ten years plus. As you would think, if they've still been in that post for such a long time, then potentially it has been very good performance that has kept them there. We'll now move on to number five in our list of tactics to look out for when researching funds, and that is to not buy every funds you like the look of.
• 14:06
  Sam Benstead: Absolutely. And I think this is a really, really important one. So when I started out interviewing fund managers seven years ago or so, everybody I spoke to was so, so persuasive, and I wanted to go home and and buy their funds immediately. But I think it's really important that when reading fund fund commentary, when listening to podcasts with fund managers, when watching our videos, you do make a choice which is right for your portfolio, and you don't just try and buy a little bit of everything because the fund manager speaks very confidently and passionately about the market they are investing in. Almost all fund managers will say it's a great time to buy their market, and that's something that myself and Kyle experienced and always try and push back against.
• 14:51
  Because they are salespeople, they're they're running money, but they're also trying to gather assets as well. So it's very important to look at their fund and think about how it might fit into your portfolio, Think about whether you already have an active or a passive fund, which works in that market. Do you really want to switch out funds to buy it, or you're gonna hold both of them at the same time? So asking those questions is really, really key. And if you don't do that, you might suddenly end up with thirty, forty, fifty funds in a portfolio, each with 50 shares.
• 15:23
  And at that point, you might as well just own a passive fund.
• 15:27
  Kyle Caldwell: Completely agree, Sam. I think if you've got over 15 or 20 funds, you should really take a hard look at your whole portfolio and consider whether every single fund in the portfolio is bringing something different to the party and earning its keep and its adding value to your portfolio. As Sam mentioned, if you own a number of similar funds, say you own five or six or seven funds that invest in The UK market, you end up owning hundreds of shares, and your portfolio then ends up looking like the wider market, and it'll perform like it as well. And if you wanna own the wider market, then that can be achieved much cheaper through an index fund or an ETF.
• 16:09
  Sam Benstead: A good way of controlling the portfolio could be to do an annual review. You can look at which funds have done well, which have done poorly. You could perhaps rebalance, and then just think about over the next twelve months or twenty four months about the sectors and and markets that you might want to own that you find interesting, and then go from there and and try and build a a clever portfolio that you can then stick with for a year or so.
• 16:34
  Kyle Caldwell: This now leads me on to item number six on the list. So as part of a review of a portfolio, say once or twice a year, it's important to watch out for fund manager changes. So with active funds, there is the prospect of the full manager or the whole full management team jumping ship or being moved on internally and replaced by another full manager or another team. This does pose a problem for investors in regards to whether you should follow the full manager out the door or place their faith in the new full manager or managers that are taking over. For me, it's important to assess key person risk.
• 17:15
  I will consider whether one full manager has been highly influential in calling all the shots or whether it's being more of a team approach with a couple of named co managers or deputy full managers on the funds. If it's been one full manager that appears to be calling all the shots, then their departure to another firm or their retirement is arguably more of a blow. Another important thing to consider is whether under a new full manager, the investment objective and approach is gonna change. Now in most cases, the investment process remains the same as they wanna keep investors on size. But if that isn't the case, then it's no longer the same funds as when you bought it.
• 18:00
  So it is time to consider whether to keep it or move on. Now a fund change in its investment approach is not necessarily a bad thing. There'll be a reason for the change, and that change in approach could actually lead to improved performance. However, if the fund is not doing what you want it to do, it's probably then time to sell. So for give an example.
• 18:23
  If you bought the funds for its income purposes and then it changes to no longer paying income or the amount of income it is paying reduces quite markedly, then I would then consider moving on. And as well as checking that the same full manager and full management team is in place, performance is also very important to assess when you're researching funds. However, in the case of considering introducing new funds into your portfolio, there's the danger of performance chasing, which is number seven in our list of tactics. Sam, I'll pass the baton to you to explain.
• 19:01
  Sam Benstead: So I think this is something that a lot of investors get wrong initially when they they start buying funds. So they look at annual reviews or quarterly reviews or or research pieces looking at the best performance over the past three or five years or so, and they think, wow. That funds double its money for investors last year. I want a piece of that. If only I'd invested a year ago, if I invest now, it might do the same.
• 19:28
  And I think during the pandemic, a lot of investors, particularly first time investors, but also experienced ones, looked at the amazing returns from from technology shares in 2020 and early twenty twenty one and then piled in at the top of the market, and they're yet to recover what they invested. I think that's a real warning sign that as we're told so often, past performance does not indicate future returns, and it's this is incredibly true. So looking at the best performance over the past couple of years is actually a very dangerous thing to do.
• 20:02
  Kyle Caldwell: And it goes back again to looking under the bonnet and assessing why has that funds performed well. Has it been a favorable backdrop for the way the funds invests for its for its investment style, or has it been a favorable backdrop for the theme or sector it invests in if it is specializing in a certain area? And the thing I think about when looking at a strong performing fund is trying to remember the that funds, it's delivered strong retains for other investors rather than myself. And it's then assessing whether over the next three to five years or longer, whether that level of retain will be sustained. I'm taking a view on will performance continue to be as strong as it has been over the past couple of years.
• 20:49
  Sam Benstead: Definitely. So I'd look at a fact sheet if a fund's done really well. And if it's a growth if it's a growth focused fund, just look at the size of the top positions. If Nvidia has, you know, doubled over the past year and it's the top holding at 10% or like in some investment trust in early twenty twenty and twenty one, Tesla became a very large position. That would be a bit of a warning sign if a company's done extremely well and it's still the largest position.
• 21:17
  It shows that they expect it to keep going up. And often, with companies, a long run of strong performance is followed by, a less good run. For a value fund, a lot of fact sheets will actually put the price to earnings ratio of the portfolio on there. And if a value fund is starting to look expensive, and for that, I might say if the earnings ratio is kind of in line with the market, so that's about 14 times for The UK market at the moment, The value fund is starting to look expensive. That means they're holding a lot of their winners.
• 21:49
  I like to see in a value fund that's done well a cheap portfolio still, meaning that they've sold their winners and they're reinvesting the money back into cheaper shares.
• 21:58
  Kyle Caldwell: And as ever, diversification is key. If you invest in different assets, different fund styles, different regions, then over time, some investments will do better than others. And over the long term, this should smooth your returns, which helps to keep a lid on risk. And also as well as smoothing returns, it gives a portfolio ample opportunity to also grow. As well as the dangers of buying a fund on a hot streak of form, With investment trusts, there's also the risk of buying on a premium, which is number eight on our list of tactics to consider when researching collective investments.
• 22:37
  So for those not as familiar as others with the investment trust structure, investment trusts trade on a premium when their share price is trading above the value of their portfolio, so the value of the underlying investments, which is known as the net asset value or NAV. And when that's not the case, when the share price is trading below the net asset value, then an investment trust is trading on a discount. Now in the case of premiums, as a general rule of thumb, I was urged caution of investing in any investment trust that is trading on a premium of over 5% and certainly over 10%. Now the reason why is because over time, there've been various examples of high premiums not being sustainable. Over time, market conditions change.
• 23:33
  Investor sentiments can also change, and this can have the effects of premiums cooling. And when premiums do cool, that harms your share price total return. One sector that's a case in point is the renewable energy infrastructure sector. So ahead of interest rates rising from rock bottom levels, this sector was very popular with investors. And as a result, the majority, if not all of trusts in that sector, were trading on a premium.
• 24:06
  So at the 2021, renewable energy infrastructure trusts were trading on an average premium of 7.2%. At the time of this recording in early August, the average trust in that sector is now on a discount of 24.5%. That's been a really big move, and it has harmed the share price total returns of investment trusts in that sector. I won't go into too much detail now while that sector has been out of favor, but the main reason has been rising interest rates, which has meant that investors have been looking to dial down on risk. They've been eyeing up safer alternatives such as money market funds.
• 24:48
  And as renewable energy infrastructure trusts pay a high level of income, they have been less attracted to taking on risk to achieve a higher level of income. And, also, with investment trust discounts, just wants to make the point that while investment trust discounts do offer investors the opportunity to potentially pick up a bargain, it's important to remember that investment trust discounts, they tend to converge to the mean discount rather than to the net asset value. So that is something to bear in mind. So if you see an investment trust on a discount of, say, 15%, that does not necessarily mean that over time that 15% discount will be eliminated. That particular investment trust discount at 15% could be the same as its five year average discount figure, so it's not necessarily a bargain in that particular case.
• 25:43
  Let's now move on to number nine on the list, which is to be wary of being seduced by a compelling investment story, trends, or theme. Sam, over to you to explain.
• 25:57
  Sam Benstead: So this one is is really important, and we're talking here about thematic funds. So these are funds that own shares that all align to a certain investment theme. So it could be artificial intelligence or cybersecurity or uranium, they all have companies that should do well if that type of market is performing well. But, actually, the reality is thematic funds generally don't make good investments. So research from Morningstar published recently found that over the past five years, only 20% of thematic funds have beaten broader indices, and that's according to data looking at thematic funds versus the MSCI World, if that's applicable to them, or the S and P 500, if that is the most relevant index for the thematic fund.
• 26:46
  So four in five not outperforming simple tracker funds and Morningstar found that the worst culprits were thematic funds in the life sciences, wellness, nanotechnology, and food sectors, and they even found that AI funds only just beat their respective indices over the past five years despite AI really, really taking off. So you would have done as well out of AI by just own by just owning The US index over actually owning a dedicated AI fund, which I think is really, really interesting. But there is one exception. So defense thematic funds have done amazingly well recently. But for me, it could be a sign that they are going to go through a less hot period in the future.
• 27:33
  But I do think thematic funds do have a place in portfolios if you're using them instead of picking your own shares to get exposure to a theme. So with just one ETF, you can pick up a basket of shares involved in a certain theme, and that is a far more efficient and less risky way of picking your own shares to try and build a diversified exposure to an investment theme.
• 27:57
  Kyle Caldwell: I completely agree, Sam. I think investing in a thematic forms can certainly have a place in a well diversified portfolio. But the thing to remember is that investing in a long term theme is over the long term, so you need to adopt a long term mindset and approach. There is the danger of spotting a theme a bit late on and buying when valuations are high. I think this is a particular problem if you invest in over the short term as opposed to investing over long term of, say, five to ten years plus.
• 28:32
  Sam Benstead: And that valuation point is really relevant when the thematic fund is new. Fund management groups, as we know, are out there to make money, and if they pick up on interest from investors in a certain idea, they're then gonna be rushing to build a product that they can sell. That might take them six months to a year. And by that time, it might be at the top of the market, and you've missed actually the really big run up in share prices.
• 28:59
  Kyle Caldwell: And in terms of good stories, don't always make great investments. Another very short point I want to make is the the importance of being aware that stock market and economic performance, they're not always aligned. So for example, high economic growth for an emerging market country does not always translate into strong stock market returns. On the other side of the coin, just because economic growth in a particular country or region is sluggish does not mean that it it's not gonna make a great investment over the long term. One example is Europe.
• 29:35
  If you invest in Europe three to five years ago and and invested in the average funds, you'll have made a very good return despite all the noise about how economic growth in Europe is very sluggish and the outlook economically looks bleak. And finally, last but not least, tenth on our list is to position size appropriately. So what I mean by this is is in terms of when you invest in a funds to not have too much exposure to one particular funds. So for around a year, I was writing a column for the telegraph called rate my portfolio, where telegraph readers would send in their portfolios and ask myself to give my thoughts on their portfolio. There's a number of cases where I saw portfolios come in where the reader had more than 50% in one particular funds.
• 30:32
  And in some cases, it wasn't like a multi asset funds where you could have the lion's share of a portfolio in theory in. It was in some cases, it was one fund investing just in one region and also not globally as well. So I think it's important to not have all of your eggs in one fund basket as this as as I've just coined a new saying there. But, also, it's important to not have too many holdings that are too small and therefore too insignificant to make a difference to your overall portfolio returns. If you have a holding of, say, 2% or less than 2% in one particular funds, the chances are it's not gonna move the performance dial either way even if it performs very well.
• 31:16
  Sam Benstead: Yeah. That that's a really key point, especially if a fund has done really well and it might have gone from a a five to a 10 to a 15% stake in your portfolio. And actually, that might not be suitable for the type of fund that it is. So, yeah, it's really important to keep an eye on position sizes, particularly if you're investing in a in a niche theme or a sector or or a market rather than a really diversified global option.
• 31:43
  Kyle Caldwell: I completely agree, Sam, and it goes back to the points made earlier about having a regular review of a portfolio once or twice a year and rebalancing, which involves selling some of your winners when they have a strong period of performance. Rebalancing allows you to maintain the risk profile of your portfolio that it was when you first put it together, and it's a very important way to keep a lid on risk and not have a portfolio that then becomes too risky for your needs and objectives. That's all we have time for today. My thanks to Sam, not just for today's episode, but for his various podcast appearances that he's made over the years in helping to get across educational information in an accessible manner. And thank you for listening to this episode of On the Money.
• 32:35
  If you enjoy it, please follow show in your podcast app and do tell a friend about it. If you get a chance, please do leave us a review or a rating in your podcast app too. We'd love to hear from you, and you can get in touch by emailing otm@ii.co.uk. And in the meantime, you can find more information and practical pointers on how to get the most out of your investments on the interactive investor website, ii.co.uk. And I'll see you next week.
• 33:07
  Hi.