What to look for in mutual funds

The criteria that mutual fund managers use to select their assets vary widely according to the individual manager. So when choosing a fund, you should look closely at the manager’s investment style to make sure it fits your risk-reward profile.

Investment style is incredibly important because of the way that investing works. Both risk and return are connected to style. According to current practice portfolio theory, you can optimise a blend of styles for diversification, balancing reward and risk.

Here’s a look at a six common investment strategies among fund managers.

• Top-down investing

• Bottom-up investing

• Fundamental analysis

• Technical analysis

• Contrarian investing

• Dividend investing

Top-down or bottom-up investing

Top-down investing strategies involve choosing assets based on a big theme.

For example, if a fund manager anticipates that the economy will grow sharply, they might buy stocks across the board. Or the manager might just buy stocks in particular economic sectors. If the manager expects the economy to slump, it may spur them to sell stocks or purchase shares in defensive industries.

Bottom-up managers choose stocks based on the strength of an individual company, regardless of what’s happening in the economy as a whole or the sector in which that company lies.

The great advantage of top-down is that you’re looking at the forest rather than the trees. That makes screening for stocks or other investments easier. Of course, managers might be wrong on their big idea. And even if they’re right, that doesn’t guarantee they’ll choose the right investments.

A bottom-up manager benefits from thorough research on an individual company, but a market plunge often pulls even the strongest investments down.

Fundamental or technical analysis

Fundamental analysis involves evaluating all the factors that affect an investment’s performance. For a stock, it would mean looking at all of the company’s financial information, and it may also entail meeting with company executives, employees, suppliers, customers and competitors.

Technical analysis involves choosing assets based on prior trading patterns. You are looking at the trends of an investment’s price.

Most managers emphasise fundamental analysis, because they want to understand what will drive growth. Investors expect the stock to rise if a company is growing profits, for example.

Some managers use both fundamental and technical analysis. If a stock has good fundamentals, it should be stable to rising. If it’s not rising, the market could be telling you that you are wrong or you should consider focusing on something else.

Contrarian investing

Contrarian managers choose assets that are out of favour. They determine the market’s consensus about a company or sector and then bet against it.

The contrarian style is generally aligned with a value-investing strategy, which means buying assets that are undervalued by some statistical measure.

The risk with this strategy is that the consensus is right, which results in wrong bets and losses for a contrarian manager.

Dividend investing

As the name suggests, dividend funds buy stocks with a strong record of earnings and dividends. Because of the stock market volatility of recent years, many investors like the idea of a fund that offers them a regular pay out.

Even if the price goes down, there is still some income being generated, and it is a good way to supplement income if you’re retired.

Most experts advise diversifying among investment styles, and in the end, a balanced way of looking at things tends to create fewer errors.

I hope that this has given some insight into the various ways that managers use to build their portfolios and manage their funds on your behalf.

The Writer is regional director at Devere Acuma.