Get out your crystal balls, PEP pickers

Question: How do you pick a good PEP? Answer: Gaze into your crystal ball. You think I'm being flippant? Listen to what analysts at the WM Company had to say after studying returns from unit trusts (the stock market funds held inside your PEP) over the last 20 years. Don't be put off by the jargon; this is dynamite.

"Over the entire period of the study, the probability of selecting a top-quartile performer based on historic top-quartile performance was no better than would be expected by chance ..." (my italics).

A "top-quartile" unit trust is one which performs among a sector's top 25 per cent of funds. The WM Company analysed the UK Growth & Income sector, where the funds can be compared directly with growth in the FT-SE All Share index of UK stock market-quoted companies.

The question is whether you have a better chance of making lots of money by buying an actively managed PEP, where a manager selects shares using skill and judgement, rather than just buying a tracker fund, which follows the All Share index.

Over the 20-year period, the position of the FT-SE All Share index at the end of each year varied hugely. In 10 of the 20 years recorded, the All Share finished in the second quartile of returns (so in the top half of the performance table). In 1987, it was in the bottom quartile.

This goes to show how much active management can do for your cash if you hitch a ride with a good PEP fund. Another survey last week showed the ABN Amro UK Growth Fund was the best-performing PEP over the last 10 years, returning pounds 35,092 on the original pounds 6,000 invested - pounds 4,600 ahead of its nearest rival.

So you could opt for the ABN Amro fund and hope it keeps growing. But, disturbingly, the WM report suggested: "Investing in a bottom-quartile fund would give a better than random chance of achieving top-quartile performance in the next (five-year) period."

Overall, the longer you leave your money in an actively managed fund, the more likely it is to underperform the index. Over five years, your PEP has a one-in-four chance of doing better than the stock market. Over 20 years, that reduces to four funds out of the 46 which have a full performance history.

Virgin Direct, which runs a huge tracker fund, commissioned this research. It must be pleased. But the big active-fund managers point out that they have a wide range of active funds; if one stops performing, you can switch to something better. And if you are thinking of investing abroad, you may do better with an active fund: HSBC research shows the majority of European funds have outperformed their benchmark indices over the past five years.

So how do you spot a good PEP? The WM Company came to the following conclusion: "The key to benefiting from active management is the identification of superior managers before their superiority shows." In other words, get out those crystal balls.

n i.berwick@independent.