Compiling a shortlist of appropriate funds takes time and effort and research and the support of a good adviser is important if an investor is to be guided towards the right funds that suit their own investment goals
The fluctuating stock markets of recent years have challenged many investors and advisers into reassessing their investment portfolio.
Those investors in the worst cases who bought during the fanatical days of the technology boom in the late 1990s were burnt and suffered three years of falling markets.
Many of them were first-time investors who bought funds in the belief that they couldn't loose out and, in turn, sold after the crash, having lost confidence in their investment, and much of their money.
It is therefore a tough challenge for intermediaries and fund companies to bring those investors back to mutual funds, or to retain those clients who are understandably concerned about the prospect of losing further capital in their portfolio.
In this environment, providing sound advice is critical and forms the bedrock of building trust between an adviser and their client.
Knowing that a fund meets personal financial objectives is fundamental to building this trust and in turn developing a portfolio that can be used to finance long-term objectives such as retirement or other more medium term goals such as school fees or mortgage repayment.
With the introduction of Ucits III and the potential increase in non-UK-domiciled funds wishing to grab a slice of UK retail assets, the advisory market faces a thorough job to guide investors to appropriate funds.
Even those clients that do understand the benefits and risks of collective investments are increasingly faced with a difficult choice with the ever increasing number of funds available.
With almost 9,000 collective investment funds (including life and pension portfolios) currently available to be marketed in the UK, intermediaries have a tough task on their hands.
Compiling a shortlist of appropriate funds takes time and effort and research is important if an investor is to be guided towards the right funds that suit their own investment goals.
The result of placing a client in the fund that is right for him or her will increase the likelihood of a satisfied investor and enhance the client/adviser relationship, which will improve client retention levels and in turn benefit the industry as a whole.
It's my belief that unsuccessful investing results more frequently from investors selecting funds that don't suit their own particular investment requirements, rather than them being placed in poor performing funds.
The point is it is more important to match the right fund to the right investor based upon their specific individual needs.
Obviously, not all investors are the same, it is critical to understand that they may have different investment time horizons, risk profiles and priorities for their own future finances.
Once the question 'what goals are most important to the investor' is answered, advisers can then research which funds are best at meeting those goals.
Does the investor place a high premium on growth of their capital? They might wish to protect the capital they have spent years building. Is their emphasis on consistency of returns? Perhaps they believe that product cost is most critical to them, as they may believe that they get what they pay for.
And what is their personal understanding of risk? Are they capital risk tolerant or risk averse - and to what extent? The risk/return relationship should be a major consideration for clients.
However, it is almost impossible to interpret an investor's attitudes or reflect the various risks affecting an investment in one simple, easy to understand way.
Part of this process can be helped through the use of fund rating systems. Our own Lipper Leader system centres on the relationship between the adviser and investor. In fact, the touchstone of the system is its relevance to the investor, matching funds to an investor's individual investment goals.
It does this by looking at four separate aspects for each fund; one to identify absolute performance (total return), one to identify cost (expense) and, two separate risk ratings - preservation and consistent return.
Growing capital over time is obviously of major importance for most investors. The Lipper Leader Total Return rating provides a simple graphical representation of funds that have performed well over three, five and 10 years within their Lipper classification.
Funds are scored one to five, with the top quintile performing funds in their category receiving the Lipper Leader accreditation whilst the worst quintile performers are scored five for total return.
While total return shows one snapshot view of performance it does not show how these returns have been achieved. Did funds that score one for total return over five years gain all their performance over the last quarter or has this performance been steadily built up over the five-year period?
The Lipper Consistent Return rating provides a picture of how these returns have been achieved. Again, funds are measured over three, five and 10 years, but, more importantly, for each of these three periods the movement of performance over the entire time is also taken into account.
As an example, for a five-year measure the excess return against the peer group category is measured over 111 separate periods, these being 60 months, 20 quarters, 10 half years and so on. These excess returns are then adjusted by Lipper's proprietary Effective Return calculation.
This adjusts the result by valuing a fund with a 'smooth' return curve over a fund with a more volatile or 'jagged' performance curve.
The resultant Lipper Consistent Return rating shows how consistent any performance returns have been over three, five and 10 years. Those funds rated Lipper Leader (scoring one) for Consistent Return have greater consistency and stability in their returns within their peer group whereas funds rated five for Consistent Return are more volatile in achieving their absolute performance within the classification.
Investors who have a portfolio they wish to protect will take great value in the Lipper Preservation rating.
The Preservation score shows how likely funds are able to retain their initial capital investment. Funds are measured against other funds in their asset class by calculating the sum of negative returns each month over the periods (three, five and 10 years again). The resultant rating of one, or Lipper Leader for Preservation, shows those funds that are more likely to retain their initial capital, while those with a Lipper Preservation rating of five are more likely to suffer from capital loss.
By way of example we see Smaller Companies or Emerging Market funds on average receiving three to five while UK Equity funds are far more likely to receive a one or two score for Preservation.
The table above right shows the average preservation rating for the IMA equity classifications.
Finally, as a measure of costs of fund investing, the Lipper Expense rating measures the funds TER against others in the classification. Funds that have the lowest quintile TER receive a Lipper Expense rating of 1 (Lipper Leader for Expense) whilst those with the highest quintile TERs receive the Lipper Expense rating of five.
While no measure can predict what a fund will do in the future, the Lipper Leader system can be used by advisers as a toolkit to more easily identify a short-list that fits investors own specific goals from the plethora of funds available in the market.
While these ratings used alone show a picture of certain aspects of funds, the real benefit of the Lipper Leader system is gained from using more than one Lipper rating together.
For example, a client just embarking on investing may have a very long term investment horizon, he/she may be more willing choose absolute performance and consistency of that performance above preservation of capital or cost, as they may believe that you are more likely to achieve better returns with 'riskier' funds or that you pay for what you get. Those funds with a Lipper Leader accreditation for Total Return and Consistent Return will be of priority for this client.
Those investors at the other end of their investment life cycle or nearing retirement will take a different view. Protecting capital and product cost may well be the highest priority and so funds with Lipper Leader accreditation (scoring one) for Preservation and Expense will be looked at as priority.
Finally, as an investor's circumstances change, it is important for advisers to view the Lipper Leader ratings scorecard of all four measures. This provides a simple picture of how a fund fits the need of the specific investor.
In summary, not all investors are the same and this is why I am so passionate about Lipper Leaders as an advisor toolkit. Good advice and fund selection is not simple and whilst fund ratings form only part of the advice process, no-one can predict the future.
Successful fund ratings build trust between the investor, adviser and fund promoter.
The challenge is to help advisers point clients to the right funds for them, finding the funds that fit.
For further information on Lipper Leaders contact [email protected] or go to www.reuters.co.uk/lipperifa
