How do we choose the Foundation Fundlist?

The Foundation Fundlist highlights what we consider to be good-quality fund in each major sector for new investment.

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  1. Rob Morgan

Through Charles Stanley Direct you can choose from thousands of investments including shares, funds and investment trusts. The range of choice can be bewildering for some people, so for those wishing to narrow the field we offer the Foundation Fundlist. This highlights what we consider to be good-quality funds in each major sector for new investment, and it could be a good starting point for your own research.

The list incorporates actively managed unit trusts and investment trusts, which try to beat the performance of their respective market, as well as a selection of passive funds or trackers that aim to replicate the performance of a market and keep costs low. All funds are chosen on merit rather than for any commercial reason.

More than just past performance

The actively-managed funds and investment trusts on the Foundation Fundlist are all managed by individuals or teams with strong long term track records, who we believe have the ability to generate outperformance.

We don’t just look at past performance. The long-term record of a fund or trust is worth analysing, but it only tells you so much. It is more important to gain a full understanding of how it is managed, why it has performed the way it has and what conditions it will likely perform best in going forward.

For instance, the approach of some managers is more likely to outperform in rising markets. Others tend to protect capital better during less favourable market conditions. This can help put performance into perspective. If the ‘style’ of the fund is conservative and contains predominantly solid, resilient businesses, it is likely to underperform in a market rally led by more economically-sensitive shares.

Looking under the bonnet

The finer detail of how a fund is constructed is also important in explaining performance with and certain sectors or regions outperforming others at different times. In addition, a ‘value’ approach that targets cheap but unfashionable companies tends to result in very different performance to a ‘growth’ philosophy of seeking faster-growing businesses that are usually more expensive. 

It is important to compare apples with apples, especially in a broad sector such as the IA UK All Companies. As well as funds concentrating on the FTSE 100, this sector contains funds invested predominantly in smaller or medium-sized companies. These may perform very differently to a portfolio of larger firms.

By meeting with fund managers on a regular basis over a long period of time we gain an insight into their particular fund management style, and the types of environment they can be expected to fare well or poorly in on a relative basis. In this way we can gauge how good they are at picking stocks, aiming to sift out the skilled fund managers from the ones who have simply been in the right place at the right time.

We do not always get it right. Funds on our Foundation Fundlist can do have periods of underperformance, and this is to be expected anyway as a broad range of styles and approaches is represented meaning they can’t all outperform at the same time.

In recent years some of the ‘stars’ of the list have been in funds orientated towards high growth companies or those perceived as having high certainty of future growth in earnings. Scottish Mortgage Trust is an example of the former. An unashamedly high conviction investment trust seeking growth opportunities from around the world, and a constituent of the list from outset in 2013. Terry Smith’s Fundsmith Equity, a fund we added in 2017, is an example of the latter.

In contrast, more value-conscious managers aiming to uncover cheap, underrated shares have had a tougher time. Mark Barnett’s Edinburgh Investment Trust and Aberforth UK Smaller Companies Trust are two instances, with recent underperformance exacerbated by exposure to unfashionable companies connected to the UK domestic economy.

Differentiation

In our assessment we also look at how different the make-up of a fund is to its index. If it isn’t much different it is unlikely to outperform (or underperform) by a significant margin. ‘Closet trackers’ are the worst of both worlds in our view – funds with more expensive active management fees but whose portfolio, and performance, doesn’t behave much differently to a passive fund.

We are more likely to favour an active manager who follows their convictions to construct distinct portfolios that fully reflect their views. However, this must be balanced with the pragmatism to control risk sensibly and not to “fall in love” with any particular company or sector.

Wise owl or future star?

Experience counts for a lot in fund management, and we only usually consider managers with track records of five years or more. However, we are keen to investigate up-and-coming managers too – the potential stars of the future – who are unproven but may have the advantage of being out of the spotlight or a smaller, more nimble fund that can better harness all their stock ideas. By tracking these managers at an early stage of their careers we hope to identify candidates for the list before they become more widely known.

A straightforward option

We also understand that many investors wish to use passive funds in their portfolios for reasons of simplicity or cost. Therefore we have included a range of these on the Foundation Fundlist. Covering the major investment areas these simple portfolio building blocks are chosen for their transparency and value for money. Likewise, we assess active funds for clear and fair charging structures.

Changes to the list

From time to time we change the constituents of the list. This could be because a major event occurs such as a fund manager leaving, or it may be more subtle. We may gradually gain or lose conviction in a fund leading to new ideas and substitutions. When making any changes we have to balance patience and decisiveness and do what we feel is best for the long term. Ordinarily, we expect there to be only a few changes to the list each year. An explanation of any changes are published on the Research section of the website.

Please note that while we believe the Foundation Fundlist can highlight fund options worth your attention, and a good starting point for your own research, inclusion does not imply a specific buy recommendation. Similarly, removal is not a suggestion to sell a fund. As always, the value of investments can fall as well as rise so you could get back less than you invest. If you are unsure on the suitability of the investment you should seek professional financial advice.

 

Past performance is not a reliable guide to future returns. This website is not personal advice based on your circumstances. No news or research item is a personal recommendation to deal. Investment decisions in fund and other collective investments should only be made after reading the Key Investor Information Document or Key Information Document, Supplementary Information Document and Prospectus. If you are unsure of the suitability of your investment please seek professional advice.

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