How Money Observer's 2017 Fund Award Winners are chosen

What does a successful investment fund look like? It’s not all about the very highest performance, because the likelihood of such achievements being repeated year in, year out over any manager’s tenure (or any investor’s ownership of the fund) is very, very low.

Top performance one year can all too easily be followed by a moribund showing the next – amounting to a rollercoaster experience for those investors who cling on. But long-term investors, including many Money Observer readers, may well be willing to sacrifice a modicum of performance if they can feel reasonably confident that the fund manager will be able to pull off  similar achievements in the coming years.

So the Money Observer awards aim to identify the funds that have pulled off the strongest combination of performance and low volatility within a wide range of Investment Association sectors. In other words, we look at risk-adjusted returns. We do this by assessing risk-adjusted performance over three years, but then filtering out any funds with a poor showing over any one of those three years.

To that end, we have used performance data to 31 March 2017 provided by Morningstar, based on returns from the most expensive ‘clean’ (commission-free) share class that is widely available to retail investors. Using the most expensive share class means we can present a ‘worst-case scenario’ in terms of returns for each fund.

Our number-crunching produced a list of winners that have not only delivered sector-beating returns, but have also minimised the alarming swings in performance from one year to another that characterise so many of their peers. They may not be the highest flyers, but they have achieved decent returns from year to year, without excessive risk.

Rewarding consistency

The 39-strong list includes 23 of Money Observer’s 2017 Rated Funds; additionally, more than a third of the winners (14) were also awarded accolades in the 2016 or 2015 fund awards.

That number is somewhat lower than last year, when 21 out of 45 winning funds were returning after taking gongs the previous two years. It reflects the significant change in investment trend over the past 12 months, as value-oriented funds returned to favour after several years of disappointing returns compared with peers more focused on ‘quality growth’ companies.

However, the fact that a significant proportion of our past winners have survived and thrived despite that sea-change in investment conditions is testament to the rigour and experience of these managers. And it does underscore the fact that even in the most uncertain of times, past performance, effectively assessed, can be a useful pointer to fund quality and reliability.

For more on how our 2016 winners got on over the past 12 months, click here.

METHODOLOGY

CONTENDERS

Funds, including offshore domiciled funds, must be members of an Investment Association (IA) sector and offer a sterling or hedged-to-sterling share class. All charity, exempt, institutional and private funds are excluded, as are all passive index tracking funds.

Each fund has a minimum of £15 million of assets under management (AUM), as at 31 March 2017, and a qualifying history of at least three years (with no breaks due to any material change in fund structure, objectives or governance). Contenders for best smaller fund awards are those with AUM of £15-£150 million. Contenders for best larger fund awards are those with AUM of £150 million-plus.

For these awards we assess the most relevant private investor share class to measure performance. This is the IA’s primary share class: the highest-charging unbundled (free of any rebates or intermediary commission) share class freely available through brokers and platforms in the retail market.

QUANTITATIVE METHODOLOGY

Data for the awards was provided by Morningstar, to 31 March 2017.

The filtering process

The funds for the individual performance awards are filtered as follows:

They are ranked from best to worst on their risk-adjusted returns over three years to 31 March 2017, as defined by the Sharpe ratio. This measure calculates the level of a fund’s return over and above the return of a notional risk-free investment (the Bank of America GBP Libor 1 Month index is used). That difference is then divided by the fund’s standard deviation – its volatility or risk measurement.

The three-year ranking is filtered to include only those funds remaining in one of the top three quartiles in their IA sectors for each of the past three years, across the following measures:

  • three discrete annual periods of risk-adjusted returns as per Sharpe ratio;
  • three discrete annual periods of relative performance versus the fund’s IA sector. This filters out
    weak performance;
  • both weak risk-adjusted returns and weak returns relative to the fund’s sector (the two relative return measures).

ETHICAL/SRI FUND AWARDS

Morningstar defines ethical/SRI (now badged ‘socially conscious’) funds as those that make investment decisions based on such criteria as environmental responsibility, human rights or religious views.

An ethical/SRI fund may take a proactive stance by selectively investing in, for example, environmentally friendly companies or firms with good employee relations. This group also includes funds that avoid investing in companies involved in promoting alcohol, tobacco or gambling, or in the defence industry.

Using the same filtering process described above, contenders are derived from the following IA sectors: equity – any equity-oriented sector; mixed asset – the three mixed investment sectors and flexible investment; bond – UK corporate bond and UK strategic
bond sectors.

QUALITATIVE ASPECTS OF THE AWARDS

• Fund manager’s tenure. We favour those with a history of at least three years managing the fund.
• Access to the fund by a wide spectrum of retail investors. This excludes ‘soft-closed’ funds, which could levy an initial fee.
• The fund’s strategy. This should broadly tally with investors’ expectations for the award category.
• Where a fund’s three-year performance (after satisfying the filtering requirements) is significantly superior to another fund with a better three-year Sharpe ratio, Money Observer may favour the higher-performing fund if its Sharpe ratio is not significantly lower.


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