'Consistent' but erratic

UNIT TRUST advertisements are required by law to contain the words: "Past performance is not necessarily a guide to the future." Normally this warning is in the small print.

It is, however, a warning most investors understand. Contrary to the opinion of some investment firms, most unit trust investors do recognise that the value of their investments can go down as well as up and that future performance will be dictated as much by stock market movements as by any fund manager's skills.

Past performance is frequently no guide to the future, so it is a mystery why so many investors still rely upon historical performance figures as the principal way of picking a unit trust. That said, these figures are a good place to start - probably the best, though it is important to look at them rather circumspectly.

Five-year performance figures to 31 December 1995 tell you how a unit trust performed over that complete five-year period on that particular day. They do not tell you how the trust performed in the intervening period, or how well it did during the up-cycles of the market; nor during the down-cycles; nor what the results would look like one month earlier or one month later.

It would make sense, therefore, to look at a number of different performance measurement periods; say the five one-year periods that make up the overall five-year period. This would give you the same overall result but would also reveal the consistency of those returns. Was the performance the result of one spectacular year's performance followed by four dismal years, for example, or the result of steady, or consistent, year-on-year gains?

"Consistency" has become a bit of a buzzword in the financial community during the past five years. There is little doubt that unit trusts with the most consistent records are more likely to repeat that pattern in the future, in particular where it can be seen to have been achieved with little volatility.

But beware when looking at figures that purport to show "consistency"; be sure they relate to truly different performance measurement periods and do not include overlapping periods. For example, a trust advertised as having "consistent" above-average results over the past one, three and five years, may again have had only one good year, after four dismal years.

Unfortunately, getting genuine consistency figures that show performance for each separate year during a longer period is not easy, although Micropal does provide such a service.

Even that, however, is only the start. Having identified the most consistent trusts, the next stop is the interim and annual reports that unit trusts and other investment funds are required by law to publish. These contain a wealth of valuable information, and you do not need to be an economist to decipher them.

For starters, they tell you what stocks and shares were held at the report date. The names of the companies held may mean nothing to you but that does not matter because by asking for a copy of the previous year's report as well, you will be able to work out how many of last year's holdings are still held.

Sometimes you will find that the fund manager has sold all last year's holdings. This is referred to as 100 per cent portfolio turnover. I have discovered some trusts that have 400 per cent turnover, implying that on average stocks and shares were only held for three months. In isolation these statistics tell you little. But if the fund manager's statement, which every report contains, talks about "long-term investment objectives", you will know, at the very least, the manager is in fact a short-term trader.

Comparing last year's report with this year's report will also tell you if the investment style has changed. Check, for example, how much of the portfolio total is accounted for by the 10 largest holdings. If it was 15 per cent last year but 35 cent this year, the chances are that either the fund manager has changed (few management groups advertise that fact) or the investment process has been altered.

Of the two, the investment process is the more important; a good fund manager should have a good deputy, so if the manager joins a competitor, the investment process should remain intact. If it is the process that has changed, however, beware.

Clearly, research takes time. If you do not have that time, there are lots of independent financial advisers that do, and many of them already conduct the research I have outlined, and much more. Independent advice can be the "cheapest" fee you will ever pay, but check that your financial adviser is doing the research and not simply picking last year's top performers. Is it worth the effort? Yes. Unit trusts have an excellent long-term record. Even the average unit trust, with income re-invested, has risen in value 204 per cent after charges over the past 10 years, compared with a total return of 62 per cent for a high-interest building society account.

q Peter Jeffreys is managing director of Fund Research, an independent company engaged in qualitative appraisal and rating of investment funds.