The Motley Fool

What to Look Out for When Investing in Funds

Investing in funds are a useful alternative for investors who do not have the time or the expertise to build and manage their own portfolios. However, with a multitude of fund options in the market, choosing the one that matches your financial goals can be a difficult task. With that in mind, I have completed a short checklist for you to ensure you know what to look out for.

No. 1: Investment mandate

The investment mandate of a fund will state the key investment principles and outline how and what kind of assets the fund will invest in. It will also tell you whether the fund will use leverage, a hedging strategy, or not.

You should familiarise yourself first with your own individual goals, risk tolerance, liquidity needs, and investment time frame, and then assess if the fund’s investment mandate mirrors your goals and risk profile.

No. 2: Investment manager

One of the most important aspects of the fund is the people behind it. It’s important to read through the backgrounds of the managers of the fund before you invest.

No. 3: Track record

Another key thing to look at is the fund’s track record. Remember to gauge the fund’s performance against a relevant index. For instance, a fund that has an investment mandate to invest in global equities should be benchmarked against the S&P Worldwide index or the MSCI World Index.

You should also look at the fund’s long-term track record rather than the track record in any single year. The long-term track record will give investors a better idea of how a fund can perform on average.

The track record of a fund should also be net of fees, meaning what the investor will actually get after all fees have been paid. In essence, investors should try to invest in funds that can outperform the index over a long period net of any fees the fund charges.

No. 4: Fees charged

This flows nicely to our next point. The fees charged can have a big impact on the returns. The lower the fees charged, the more likely a fund can earn higher returns for investors.

There are a few fees to take note here. Investors should focus on the management fee, performance fee, and sales fee.

No. 5: Fund expense ratio

On top of the fees charged, it is important to look at the fund’s expense ratio, which is the percentage of fund assets used to pay for administrative, management, and other expenses. The expenses will eat into the fund’s returns and affect the long-term track record of a fund.

No. 6: Other factors

Finally, there are some other factors investors should bear in mind. First, I prescribe investing in a fund with a high watermark feature. This means the performance bonus is only paid out if the fund goes above the highest net asset value it achieved in the past. This ensures fund managers are not paid twice, simply because of fluctuations in the fund’s net asset value.

Investors should also take note of any lock-up period. The lock-up period is usually in place to ensure investors have a long-term mindset. If you are unable to commit to a long-term investment, I suggest staying away from funds for now.

The Foolish bottom line

If you’re looking to invest in funds, do sufficient due diligence. There is a multitude of fund options in the market, with many underperforming the index over the long term. As a rule of thumb, investors should ensure they look into the fund’s long-term track record to find the fund that gives them the best chance for market-beating returns.

The information provided is for general information purposes only and is not intended to be personalised investment or financial advice. Motley Fool Singapore contributor Jeremy Chia doesn’t own shares in any companies mentioned.