Spend, Save and Invest Smartly

Investment Strategy and Process



In selecting any investment, there are some very basic premises that need to be researched before actually going into investing. The fund should be analyzed for :

  • How easy it is to understand
  • Its consistency
  • Its definability
  • Its soundness

First and foremost, the investment process should be simple to understand. As simple as seems it sounds, it is an important starting point.

It might take a little work, but tracing the investment process back in time will determine whether the fund's manager is reliable with his or her strategy. For instance, making major changes in beliefs as the tastes of investors change may indicate a manager who chases trends. The misunderstanding can be magnified by the dizzying array of mutual fund names like "Select Intermediate Growth Opportunities Fund" or the "International Direct Select Diversified Balance Fund". At the same time as the mutual fund manager who bends his or her sails to the wind trying to cash in on the latest trend may be successful over small periods, it requires outstanding foresight and a bit of luck to call the tops and bottoms of those trends.

It is also important to confirm that the strategy is definable. For an instance, can you hook the manager and the fund to the specific role you have hired them to do? If not, you may be investing in a fund whose manager exercises more independence than you would like to see. Lastly, does the fund have a resonance strategy? Read the strategy thoroughly and evaluate the resonance of its goals. If the strategy is based on theory alone and is relatively new, it is essential to make sure it's right for you.

Performance

Even though there is widespread information available to evaluate mutual funds and their managers from multiple aspects, it is human nature to pick the fund that performed the most excellent in most recent time period. This is unlucky, as this month's best performing funds can effortlessly be the worst performing funds next month. Then human nature kicks in again and the impulse reaction is to sell the fund. This leads investors to a predictable fence in of buying high and selling low.

One way to stay away from the trap of investing in the wrong fund is to look at :

  • Consistency
  • Relative vs. absolute performance
  • Peer performance
  • Performance over cycles
  • Personal investment

Consistency can easily be dogged by counting the number of times the manager has done well compared to other managers. This measures absolute performance and is a good first step in performance assessment.

The next step is to evaluate comparative performance, which compares a fund's absolute returns to indexes and peer groups. This applies to all types funds investing in all types of asset classes, as each class has specific benchmarks and peer groups. For an instance, domestic large cap stocks are usually compared to the S&P 500 as a yardstick and then to peer groups such as growth or value sub-universes.

International bond funds might be benchmarked against a Shearson Lehman Intermediate Bond Index and then ranked in a sub-universe of developed or emerging market managers. The explanation here is to dig deeper to find out how closely the fund is following the process it has set out to follow. It may hoist a red flag if a fund manager has outperformed his or her benchmark consistently, but has achieved returns with a stumpy correlation to the returns of the benchmark. This would guarantee further research to see how the manager achieved those results.

The outcomes will most probable be one of two things
• The mutual fund manager exhibited better-quality security selection or market timing skills, or
• The manager strayed from his or her progression on occasion to follow trends.
Either way, whether to invest in this type of fund may be a matter of personal preference; some people would like the free spirit while others have a preference a regimented process. While comparing fund performance, it is also a superior idea to evaluate how a manager has done in various market cycles. This will help the investor determine whether the manager does particularly well in good markets, bad markets or in both good and bad markets.

Finally, investors should remember to consider one of the most disregarded items: does the mutual fund manager invest his or her own money in the fund? While this may not subject for some investors, it is sure pleasant to know that the manager has some of his or her own dough in the mix.

The industry of evaluating mutual funds and their managers has grown as quick as the mutual fund business. There's an overwhelming amount of information available to investors, but there are ways to make simpler the process and evaluate the manager based on credentials, experience, process and performance in various market cycles. The key to evaluating and investing is to not rely exclusively on the rating agencies and to do your own research. You might be astonished to find that you know a lot more than you thought.

Mutual Funds
Mutual Funds