Investment funds are an excellent way to diversify your portfolio

An article from Friends First Pensions and Investments Director Simon Hoffman

27th June, 2017
Investment funds are an excellent way to diversify your portfolio

A mantra of any good investment strategy is to ensure diversification across asset classes and individual stocks. Using investment funds is a good way of achieving this. Whatever you invest is ‘pooled’ with other investors. This increases the amount for investment making it easier for the fund manager to diversify.

Some investors fall into the trap of assuming that the objective of fund managers is to make a return. This is not necessarily so. Asset managers often call their funds ‘products’ each with different features and benefits. Some have very strict rules (their ‘mandate’) on how the fund manager is allowed to invest. Some might only select a single asset class whilst others must hold minimum amounts of asset classes.

When it comes to understanding the returns a manager is looking to achieve it is important to understand how they are mandated. Most will be measured against a peer group or benchmark. The difficulty with this is that when markets are falling they are still measured against these. They will be deemed to have done very well if they lost 30% during a period when their benchmark has fallen 35%. Their objective is not to make their investors’ money, but beat a performance indicator.

Simon Hoffman of Friends First

The funds industry has evolved and a new breed of ‘product’ has become increasingly popular. These are the ‘Absolute Return’ funds or giving them their new label ‘Targeted Absolute Return’ funds. “Absolute Return” means the fund manager is trying to achieve positive returns rather than beat a benchmark. The ‘Targeted’ label makes it clear that this is not a guarantee.

Targeted Absolute Return funds generally offer freedom to go into, and out of, markets and use sophisticated techniques, giving the fund manager a chance to meet their objectives. These funds are trying to behave differently to investment markets. They rely more on the skill of the investment team than traditional funds.

You should look at the objective of a traditional fund before investing and do likewise with Targeted Absolute Return funds. Many quote their performance objective as, say cash returns plus 4% a year over an investment cycle. I’d take these with a pinch of salt. It’s very hard to be that definitive with returns, especially over shorter time frames. There will be periods when Targeted Absolute Return funds will show losses. How the team manage downside risk is important. For example, Friends First launched Concept K, into the Irish market last year. This fund doesn’t have an explicit ‘cash plus’ target but instead is very focused on downside risk and aims to ensure that losses in any calendar year do not exceed 10%. The principle adopted here is the less you lose in a downturn, the less you must regain in the bounce.

I welcome these new funds and wonder why it took so long for the industry to launch them. They align the fund manager far more closely with the retail investor. Most retail investors want to earn more than they can on deposit, but without taking on the type of risk associated with stock markets. Targeted Absolute Return funds don’t guarantee to do this, but at least the fund manager has a very clear view that this is what they are being paid to try to do.

The views and opinions expressed in this article are those of the author.

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