Picking a Good Managed Fund

Picking a Good Managed Fund


The Editor is also the Founder of The Passive Investor website. He is a part-time practising General Practitioner (GP) with an interest in all financial and investment-related topics. He is particularly focused on the integrated use of residential property, commercial property and the sharemarket to develop effective financial strategies for wealth accumulation and distribution.

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Managed funds are investments that are on our What we WILL NOT invest in list.

There are two key reasons for this, and the first is their fees.

High fees can substantially eat into your long-term investment returns.

Many managed funds can have total annual fees of 2-3% or more of your investment returns.

Compare this to investments that we do like, such as index funds (which are like “passive” managed funds that track various indices), exchange-traded funds (ETFs – which are like ASX-listed “passive” managed funds that track various indices) and listed investment companies (LICs – ASX-listed companies that carry on a business of managing an investment portfolio) which can have fees as low as 0.10-0.20% pa – that’s a huge difference in fees!

Several studies have shown that in the long-term most “active” fund managers underperform their benchmark indices largely due to fees.

Hence if you are going to attempt to pick a good managed fund, comparing the total fees they charge would be a good starting point.

Moving on from fees, the second key reason we do not like managed funds is that we think it is very difficult for the average retail investor to further narrow down the long list of managed funds to pick a really good one.

Doing so requires you to be able to pick a good fund manager, and this requires a lot more expertise than looking at a funds historical performance record.

As they say, “past performance is no guarantee of future performance”.

To put this in context, let’s look at how the US institutional investment firm Commonfund selects a good fund manager and thus a good managed fund.

The Commonfund provides investment management services to nonprofit institutional investors such as educational endowments, foundations, hospitals, healthcare organisations and various philanthropic organisations, as well as managing the pension assets of these organisations and supporting various family offices and trusts.

When deciding how to invest their funds many of these institutions outsource the process of selecting a fund manager and monitoring their performance to Commonfund.

This extract below taken from their brochure titled Principles of Endowment Management is a great summary of their overall approach:


“The responsibility for selecting, monitoring, and balancing investment managers can weigh more heavily on the Investment Committee and business staff than they consider comfortable. The processes involved are not only specialized but quite sensitive: if you manage it all yourself, how do you explain results that miss your objectives?

For that reason, many educational institutions decide to outsource this function. It is essentially the same decision that increasing numbers of business enterprises have been making: to concentrate on their core competencies and outsource the rest of the work to specialized services.

In the interests of full disclosure, we must point out that managing investment managers constitutes the chief occupation of Commonfund. We manage managers of many hundreds of educational institutions and other nonprofits. The following discussion summarizes what we believe to be the basic principles of selecting investment managers and is not intended to promote our own capabilities.

Selecting investment specialists has itself become a specialized skill, because there are thousands to choose from, and the well-known stars do not always represent the best choice. Candidates must be investigated in depth. Performance data alone can prove misleading, especially if they cover only a short term – less than five years. Performance in less than one market cycle could tell more about the firm’s luck than skill. And past performance alone has never provided a reliable prediction of future success.

In each segment or specialization, the manager-selection process must include several necessary steps:

– Compiling a list of candidates

– Gathering basic information about them

– Narrowing the list

– Conducting preliminary due diligence

– Selecting the finalists

– Completing due diligence

– Hearing presentations of the finalists

– Making final selection

– Conducting negotiations

Starting with your first list of candidates for a particular segment of the portfolio, what do you need to know? A lot. What is the firm’s investment style? Its philosophy? What evidence is there of its commitment to that philosophy? How does the firm’s decision making process work? What kinds of internal controls does it use? What about its reporting system, its quality and timeliness?

Considering its investment approach, how will it complement the other investment managers in your roster?

What is the firm’s ownership structure? What is the quality of its senior management? What are the qualifications of its professionals? How stable has been its professional staff?

How large is the firm in terms of assets under management? How has it grown? How has it changed? Is it too large? What are its fees?

And finally, does the firm have any connection to any member of the Board? And, further, what is the Board’s position with respect to conflict of interest?

Completion of the selection does not end the process. Regular monitoring must include not only performance review against relevant benchmarks but also vigilance for any fundamental changes in the firm, which may be reason to start the selection process for that segment all over again.

A key resource for the manager of managers is its base of information on the expanding world of investment managers. The information collected about any one manager under consideration will cover every aspect of that manager’s business.

The breadth and depth of accuracy of the collected information is, of course, crucial. In our manager-information template, the questions alone take up to 23 pages.

The professional staff of the manager of managers sifts and sorts this information to help its clients institutions optimize portfolio building. By experience and education, these professionals must be capable of making the same kinds of investment decisions as the managers themselves have to make, because the manager of managers must evaluate performance and everything else about the chosen managers before any shortcomings become significant.”


If you managed to read all of that, you may see that picking a good fund manager and thus a good managed fund is certainly no easy task!

We’ve bolded two paragraphs above that we think encapsulates the key point that picking a good managed fund is a skill in itself and requires a lot of experience and education to do it well, consistently and successsfully.

Clearly it is possible to do, as professional institutions like Commonfund are able to do it, but it is a lot harder for the average retail investor to do this, particularly if you are not working in or have any connection to the financial services industry.

We’ll keep an open mind on this though, and if any of you can find a simple and practical practical way to replicate what Commonfund does we are all ears!

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