Kevfle recently posted an intriguing article called “Can we beat the professionals?’ In this he touched on some interesting questions around the investment industry, which provoked a flurry of responses from our fantastic community here at Stockopedia.

Kevfle seemed to have several questions on his mind, including:

  • Can we actually ever outperform the pros?

  • Am I wasting my time?

  • Is it easier to choose and evaluate a group of funds instead?

  • Can I achieve similar results leaving it to the pros?

In my previous article, I considered the first two questions regarding a more personalised investment approach. In the second of this two part series, I investigate the alternative option of buying funds and look at some of the difficulties that must be overcome.

Is it easier to choose and evaluate a group of funds?

Purchasing a group of funds (be they active or passive) has many advantages. Investing in a fund is an easy way to gain exposure to a certain market or asset class. They are efficient in gaining access to markets that are more difficult to trade in and and can provide the investor with a more diversified exposure for smaller investment sums.

Buying funds also requires very little time investment and you utilise the combined expertise of the talented members of the fund management team.

I will argue however that it is possibly more difficult to pick and evaluate ‘winners’ in this space.

The usual starting place for determining the level of skill of the fund manager is to look at how they have historically performed. Whilst we are all aware that we ‘cannot buy past performance’ it is still often used as a guide for how talented the fund manager is.

However due to the nature of luck involved in investment returns, past performance is a poor proxy for determining manager skill. Using returns data standalone, you would need a very long time series of return observations to have enough data to deduce a statistically significant outcome about a fund manager’s level of skill.

A popular way to filter the universe of funds is to use the Morningstar star ratings. These ratings are based on past performance and rate each fund between 1 and 5 stars, where 1 is the worst and 5 is the best. Seeing many stars on a fund factsheet may be visually appealing, however in line with…

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