Investment funds play a crucial role in financial planning choices – both before and after retirement – by helping people to build up their retirement pots through self-invested personal pensions, and to generate a regular and growing income. Meanwhile, persistently low interest rates mean a funds-based Isa can help investors achieve a superior return to that available from cash.
But by seeking potentially higher long-term returns from funds, investors take on more risk. Few people like taking risks with their savings, particularly their retirement savings. Most investors fear the idea of losing money when markets fall more than they worry about not having the top-performing fund when markets are rising. That is a pertinent point today, following nine years of near-uninterrupted strength in financial markets.
Low-cost, passive index-tracking funds can make useful core holdings in a diversified portfolio. However, investors in index-trackers are hostages to fortune, whereas a good active investment manager should be mindful of capital preservation in the bad times and produce above-average performance when markets are favourable.
This is the reason why Money Observer, in assessing candidates for its fund awards, looks for actively managed investment funds that have achieved consistently good and lower- risk returns over three years, rather than simply rewarding the top performers.
Predicting future winners is impossible, of course. However, we believe that closely analysing past returns can help to identify exceptional managers whose funds have made it through our rigorous screening process. It explains why one-third of the 2018 award-winners were also recipients of our awards in 2016 and/or 2017, with a select few funds returning to the Money Observer awards podium for longer periods.
To get on to our shortlists, funds must pass a two-stage filtering process carried out on our behalf by Morningstar (see methodology, below). Funds that have not performed well enough compared with other funds in the same investment sector in each of the past three years – on a relative and a risk-adjusted basis – are removed. To assess risk-adjusted returns we use the Sharpe ratio, which measures a fund’s excess return over a risk-free instrument, and the volatility of returns.
Performance data from Morningstar. Chart data from FE Analytics, except property charts, which are from Morningstar. All data as at 31 March 2018.