Many investors who aim to beat the market outsource decisions on buying shares to professional managers by going for funds. Immediately they meet the confusing universe of collective investments, comprising more than 4,500 open-ended funds, plus almost 400 investment trusts. There’s simply too much choice.
Short of paying for investment advice, how can investors assess if the professional managing the fund or investment trust is any good? Enter the ratings industry, employing analysts that score funds and trusts on a range of criteria.
Some ratings firms restrict the results of their analysis to professional advisers. If you use an adviser, ask to see the ratings that they use. But if you don’t, three well-respected and longstanding firms, Morningstar, FE and Refinitiv Lipper, offer public ratings for free. And Morningstar has this week upgraded its fund ratings to make them more user friendly.
Their work is independent — the fund managers don’t pay for rankings — and when you don’t have the time to do analysis yourself, it’s worth checking.
For example, Morningstar downgraded its rating for Neil Woodford’s flagship Equity Income Fund from bronze to neutral in May 2019. This was the month before the fund closed to investors after Woodford’s holdings in private, illiquid companies meant he could not sell assets quickly enough to meet clients’ withdrawal requests. While Morningstar wasn’t shouting “sell this”, for such a popular fund to have a low rating was a warning bell.
Using these firms’ rankings is definitely not foolproof. Analysts are human and make mistakes when taking into account everything from the record of managers, to fund costs, dealing frequency and relationships with the manager.
Quantitative performance research feels most scientific, as analysts study the tangible financial information. This could be the fund’s performance history, compared with the performance of a chosen benchmark index. Analysts might also examine performance consistency and compare the record during market highs and lows. The disadvantage of quantitative research is that it looks backwards and, as the financial regulator is fond of saying, when it comes to investment performance, the past is no guide to the future.
Qualitative research aims to look forward, but is more subjective. This covers hard-to-measure aspects, such as the quality of the fund manager and their team. It often involves lengthy meetings with the fund management firm to speak to staff and learn about their investment philosophy. You’re relying on the experience of the analyst — and their ability to screen out their own biases. You might also be trusting their gut instincts to a certain extent.
Research and analysis of funds and fund managers can be quantitative, qualitative or a mixture.
The FE fundinfo Crown Ratings help investors distinguish between funds that strongly outperform their benchmarks and those that do not. The top 10 per cent of funds are awarded five FE fundinfo Crowns, with the next 15 per cent receiving four Crowns. However, FE fundinfo caveats its Crown Ratings by saying they are “purely quantitative and backward looking, and, as such, cannot offer any certainty about the future”.
In April, Refinitiv Lipper published the winners of its annual fund awards. The awards are useful to find funds that are consistent performers.
Morningstar this week combined its quantitative and qualitative analyst research into a new system with one score to make navigation easier. The Medalist Rating has a simple scale of gold, silver, bronze, neutral and negative.
Morningstar has a universe of 66,365 in its fund screener tool. Of these, 2,668 have the top gold. If you add in the older Morningstar star ratings, which are a purely quantitative, backward-looking measure of a fund’s past performance, selecting only those funds with the top five stars, you are left with 397. This took me less than a minute on the Morningstar website.
And now for the separate thorny issue of ESG ratings, which aim to help investors evaluate portfolios on environmental, social, and governance factors, but have often been criticised for a lack of shared and transparent methodologies.
The Morningstar Sustainability Rating is worth checking — after several iterations since 2016, it has evolved into a measure of financially material ESG risks in a fund.
However, sustainable investors who screen for the top Morningstar Sustainable Rating score of five globes, plus the other Morningstar top ratings are left with a very limited selection of 40 funds from a handful of managers.
Your alternative is Fund EcoMarket, which offers information about investment funds that pay significant attention to sustainable, responsible, ethical and or ESG (environmental, social and governance) issues. The database, run by consultants SRI Services, is open to everyone, and is currently being updated. However, it’s designed for professionals so be prepared to do your homework. The screening begins with a choice of nine investment styles, and is followed by hundreds of multiple filters on underlying issues and policies.
If that feels too much, look at recommended lists from the major investment platforms. Hargreaves Lansdown has responsible funds within its Wealth Shortlist, while AJ Bell includes responsible funds in its Favourite Funds list. Interactive Investor goes a step further with the ACE 40, a list of sustainable investing ideas.
So now you have some tools, use them to review your fund holdings once or twice a year. And if you find a rating drops, or a fund drops off a list, the universe of 5,000 collective investments means there’s always an alternative.
Moira O’Neill is a freelance money and investment writer. Twitter: @MoiraONeill, Instagram @MoiraOnMoney, email: moira.o’email@example.com