Choosing an Investment Fund



Bryn Hamilton

Financial Advisor, Associate Portfolio Manager, and Director


For the purposes of this piece, we will be focusing on managed money and, in particular, mutual funds. An investment advisor who chooses investment funds on behalf of a client is implementing what’s called Overlay Money Management. Many advisors will have their own philosophy as to how to pick investment funds based on a specific portfolio asset allocation. 

More specifically, some funds may be chosen based on geographic or industry criteria, growth or value, or equities vs. fixed income. This article will go beyond portfolio asset allocation and dive into some things to consider about the mechanics of the specific funds to be chosen and help investors understand why they might be considered for their portfolios.


To fully understand what to look for in an investment fund, we must first understand the history around these investments. A mutual fund is an investment vehicle made up of a pool of money collected from many investors for the purpose of investing in securities such as stocks, bonds, money market instruments and other assets. The major characteristic is that investors share risk and share reward. The first modern-day mutual fund, Massachusetts Investors Trust, was created on March 21, 1924. It had an open-end capitalization, allowing for the continuous issue and redemption of shares by the investment company. After just one year, the fund grew to $392,000 from an initial $50,000 – growth of nearly 800%.

In the beginning, the fund manager had a relatively free reign to manage these funds as they saw fit by individually selecting the securities to invest in. However, things started to change around 1980 when pressures started to mount with regards to money managers under-performing their relative benchmarks. So much so that many feared losing their jobs and this resulted in a significant change to how money was being managed. Now, if a fund manager was individually selecting the securities - based on their merit and not simply because they existed on a specific index, then they are “actively managing” their fund. If the fund manager was mimicking the benchmark by purchasing the same companies with similar weightings, then this was known as “closet indexing”.

More and more managers were closet indexing for the purposes of generating similar returns to the benchmark, thus safeguarding their jobs in the short term. But the question then became: “What were investors paying for?” All funds have a management fee, and that fee must be justified. To make problems worse, it became widely known that money manager closet indexing was almost guaranteeing benchmark under-performance once management fees were taken into account. By 2009, only one third of money managers were “highly active”(meaning 80-100% of the fund’s assets were being managed actively), so the remainder or two-thirds were under-performing. Nevertheless, statistics show that highly active money managers on average outperform the benchmark by 3.64%.


There are many different criteria when selecting mutual funds and we have already touched on one(active management). To start the selection process for managed money, we need to identify the funds that are being “managed” and we can do this through identifying the core factor of “Active Management”.

Another criterion which is somewhat of a continuation of our first is Concentration or Conviction. This means that the fund’s assets are invested in a much smaller group of individually selected companies based on their quality and prospects for the future which demonstrate the money managers’ conviction in those specific companies. As a group, these companies will ideally show better results than the relative index. The holdings in the fund should show significant differentiation in holdings from the relative index and is, therefore, a typical indicator of active management.

Portfolio Manager Motivation should be considered as well. What’s in it for them? Many successful managers are also owners of the investment firms that they are a part of. Further to this we should also see if the money managers “practice what they preach” by investing their own money into the fund. There should be a clear understanding of how the fund manager is compensated and if their motivations align with those of the investor.

Cost of the investment fund is a consideration that can be viewed in a few ways. While some want the lowest cost investment, others will look for the highest net benefit after costs. It’s fair to say that if there are two funds with the same gross results (before fees), you would choose the lower cost fund for greatest net benefit. An expensive investment fund shouldn’t immediately be viewed as a negative, as this investment might end up producing the best net results and therefore, the best investor value. One thing is sure, if you are paying a fee to have a managed fund then there should be active management as opposed to closet indexing.

Performance means different things to different people. The actual performance of an investment is often very different to what investors have received. There are many investments that have performed well over time, but investor results tend to differ, because they invested too late or exited too early. This is a function of timing as opposed to the performance of the investment itself. For example, the 30yr average annual performance on the S&P500 Index is roughly 10%. The average investor only saw a 4% per annum return due to their own emotional decision-making. If we can stick with the investment, investors are allowing for an appropriate period for a money manager to produce the intended results. Statistics show us that roughly 30% of the time top money managers are under-performing their relative benchmark. This tells us that we need to take into consideration at a minimum 3yr and 5yr performance results. By extension, 10yr numbers are even more representative of how a manager handles various market conditions. A major part of what advisors do is help or coach investors through that rollercoaster ride so that they can realize and receive the results of the underlying investments.


These are just a few of the many criteria to consider when determining what managed investment funds might be included in your portfolio’s asset allocation. Advisors who implement an Overlay portfolio style of management should have a set filtration processor criteria breakdown outlined in their Investment Philosophy or Investment Policy Statement to help investors understand why each investment has been chosen and how it will help them achieve their financial planning goals. ■
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