Right now is the best time to invest for a generation according to experts up and down the country as the recession looks set to wane and undervalued stocks begin to rally. But before investing any money in the stock market, you need to be confident that your chosen fund manager has the ability to make decent returns. Finding one that can perform to a consistently high level, however, is easier said than done.
Those that do have the golden touch can easily double the value of your portfolio through wise decision-making, but someone choosing the wrong companies or sectors may end up losing every penny you have saved.
The majority of fund managers will underperform due to limited experience or a flawed investment process, says Mark Dampier, head of research at Hargreaves Lansdown. "You can ignore most of the market because there are really only a few good fund managers with long-term records," he says. "Out of 2,000 funds, we have identified about 140 we like, but could possibly narrow that down to just 20 or 30."
The past 18 months have only served to illustrate the importance of picking the right combination of fund and manager as the difference between the best and worst performing portfolios is substantial.
Even funds in the same sector – meaning they have broadly similar investment philosophies and goals – have enjoyed vastly different fortunes.
For example, the star turn in the UK All Companies sector over the past year has been the Schroder Recovery fund, which has delivered a bid-to-bid return of 20.91 per cent, according to Morningstar figures to 31 August. However, at the other end is the Gartmore UK Focus fund, which has lost an eye-watering 31.68 per cent.
It's a similar story in the Europe excluding UK sector. BlackRock's European Dynamic fund has returned an impressive 10.23 per cent over the past 12 months, while Premier's European Growth fund is down 30.44 per cent. So where do you start?
Set your investment goals before you look for a manager, advises Darius McDermott, managing director of Chelsea Financial Services. Until you know what you want to achieve, it's pointless searching for someone to fit the bill. "Investors need to decide how long they want to tie up their money, and to establish their attitude to risk," he says. "For example, equity investing should only be for longer-term investment horizons of at least five years."
Andy Gadd, head of research at Lighthouse Group, agrees. "The most important decision given the current market conditions is determining the right asset allocation for the level of risk that an investor is prepared to take," he says. Each asset class – principally equities, fixed interest, cash and property – will behave differently, he points out. At the time one asset is increasing in value, another may be falling. Combining them in an overall portfolio, therefore, can make sense.
Individual asset classes and sectors will also perform well at different times due to political and economic factors. When markets are soaring in the US, for example, funds investing in this area are likely to outperform their rivals. During 2008 the best sector was IMA Global Bonds in which the average fund rose by 16.5 per cent, according to the Investment Management Association. The worst was IMA UK Smaller Companies, where the average fund fell 40.7 per cent.
It is also important to ignore fashions and trends, points out Andrew Merricks, head of research at Skerritt Consultants. These funds may enjoy short-term periods of stunning performance, but this can just as easily come to an abrupt halt. Opt instead for managers and funds with longer-term investment goals that offer an acceptable level of risk, he advises.
It is also best to know where you want to be invested. For example, do you have faith in the long-term story of emerging markets, or are you convinced that putting all your money into companies based in Europe is the way forward? But what qualities should you look out for in fund managers? How do you know which individuals are capable of delivering the goods on a consistent basis?
According to Philip Glaze, chief investment officer for multi-manager at HSBC Investments, there are two key areas to examine: the investment firm behind them, and the fund itself, of which the manager is a major factor. "In the past people tended to think that just because an institution was big meant it was strong and robust, but recent events have proven that's not necessarily the case," he says.
Glaze likens the analysis of a fund proposition to taking an engine apart and examining each component. "We strip it down to the team, its philosophy and the process of generating new ideas," he explains. "The way the portfolio is constructed, decisions implemented and trades executed are also important."
Alongside these are "softer" factors, such as a manager's passion for the job, their commitment to improving performance and a sense of progression, he adds: "It's important investors have a strong understanding of what they're buying because the devil is always in the detail. That's why we spend so much time talking to managers."
Although you won't be able to have one-on-one chats with fund managers, you can carry out research through websites such as Trustnet ( www.trustnet.co.uk), Morningstar ( www.morningstar.co.uk) and Interactive Investor ( www.iii.co.uk). Most houses publish monthly fact sheets for each fund describing its aims and objectives, where it is positioned, and current themes. The manager will also usually write a few paragraphs explaining what he's been doing.
Then there are performance figures. Everyone warns against looking at them but they can help, says Dampier. "The longer the track record, the easier it is to start forming a judgement about a manager," he says. "They may show he has delivered over time."
However, don't fall into the trap of basing your decision solely on these past performance of different sectors and funds, because the level of returns generated may have been due to various factors, insists Gadd.
"Reasons could include the fund being invested in the right sector at the right time – or the managing happening to get several buy and sell trades correct," he says. "All the statistics show in isolation is that an investor should have bought it a year ago."
For instance, the Asia Pacific excluding Japan sector was the place to be in 2007 with the average fund returning 36.4 per cent, according to the IMA. However, the following year an investor would have lost around 33 per cent in this area.
This illustrates another important point: monitoring your chosen portfolios. Once you have made your initial decision, you need to follow the progress of your chosen fund/manager combination to ensure they're delivering. If they start losing money it's time to scrutinise what has happened. Are the figures based on unusual market circumstances, such as the bursting of the technology bubble a decade ago? Has the sector suffered problems?
It's a similar situation when a manager quits a fund. While it can be tempting to sell immediately, you may find that the investment house manages to replace them with someone of equal – or higher – stature.
In most cases it's best to follow the manager rather than their fund, argues Mark Dampier. Virtually regardless of the economic backdrop and market cycle, picking established names such as Invesco Perpetual's Neil Woodford, Aberdeen's Hugh Young, and Philip Gibbs at M&G usually makes sense. "Even the best managers are not right all the time but you can have more confidence in those with long track records of decent performance," he says.
Finally, one other possible option is to opt for a fund of funds. These portfolios are run by managers who buy into a number of other funds which enables them to spread the risk being taken while still getting access to the skills of a wider range of investment professionals.
"Fund selection is very complicated and one that is perhaps best left to specialists," he says. "With this in mind I currently favour the Lifestyle fund of funds portfolios managed by Dean Cheeseman and his team at F&C."
Fund tips: What to look out for
Five things to find out about your fund manager before investing:
1. What constraints are set by the investment house?
2. How is performance judged?
3. What personal investment guidelines do they have in place?
4. How many other responsibilities do they have within the company?
5. In what form are they remunerated?
Warning signs that it might be worth moving:
* Three consecutive years of underperformance.
* Dramatic changes to investing style.
* A manager leaving a fund.