How we Choose Investment Funds – part 2

By Huw Jones

moneyWhen introducing evidence-based investing, we like to begin by explaining why we feel it’s the right investment strategy for those who are seeking to build or preserve their wealth in wild and woolly markets.

Of course sensible strategy is best followed by practical implementation, so it’s also worth describing how we choose investment funds that we typically use in our clients’ portfolios.  We split this process into three parts and in this blog we take time to explain the second part of our process:

See part 1 HERE

Part 2: Passive vs. Evidence-Based Strategy

Once we disqualify speculative fund managers (part 1), that still leaves a relatively large (and growing) collection of funds that seek to efficiently capture various dimensions of the market’s expected long-term growth without engaging in seemingly fruitless and costly forecasting.

In this category, you’ll find two broad types of funds:

  1. Index Funds: Index funds track popular benchmarks such as the FTSE 100 or the Barclay’s Global Aggregate Bond Index, which in turn track particular market asset classes such as UK. large-cap value stocks or global bonds.
  2. Evidence-Based Funds: Evidence-based funds seek to wring the highest expected returns with the least expected risk out of similar market asset classes in a more flexible, but still rigorously disciplined manner.

The goals of each are similar, mind you, making it harder to choose among these second-round contestants. Each emphasises the importance of minimising wasted efforts and maximising the factors we can expect to control.

Still, all else being equal we typically favour evidence-based funds for the core of our clients’ portfolios. We feel they are structured to do an even better job at participating in relatively efficient markets over time.

By being freed from slavishly following a popular index benchmark and similar restrictive parameters, they can focus directly on the fund management factors that matter the most according to what the evidence has to say on the matter.

This includes most effectively capturing markets’ expected returns, while aggressively managing for market risks, minimising trading costs and dampening some of the noisy volatility along the way.