For selecting whether to make an investment to the investment fund or not, we need to think for the answers of few questions such as getting better than average return (performance fund?), if not, then avoid fund which can give us a worse than average return and lastly, can we make choices between different types of funds or not.
General people who open a trading account, most probably engage in the speculations but such behavior is not common for the mutual fund investors. People also tend to select a fund that is growing fast.
Many times, due to the support of luck, few of the fund managers or investors stay in the right direction at the right time and they earn good returns but when such tide goes out, we can see the real skill of the particular manager or investor. It is also highest into the possibility that winning fund does not always remain winner due to –
If a fund has a good touch of the fund manager then every other fund house demands the same manager and they hunt to the manager at a higher pay scale also.
When a particular fund provides a good return then it will attract the investors. Due to the higher flow of the investors, managers have to put additional money into the stocks which he already owns. Such strategies lower down the returns. Sometimes, we can play a few risky strategies with small funds but the same is not suitable for the huge size fund.
As the fund grows bigger, the fund manager gets higher fees on it. So that reluctant to lose the higher fees and they started playing the game which everyone else is playing. If we see that top holding of the different funds then it will be more or less similar to each other. So, for protecting their higher fees, they do not focus on their ability to generate a superior return. They believe in getting wrong conventionally rather than unconventionally.
If we see then the majority of the funds having a similar stock as a top holding.
On the other view for good return from the fund when –
A fund manager is the biggest investor of the fund then his motive and motive of other investors will be the same and they work for generating a decent return.
Expenses of the fund are lower than definitely, the fund provides better performance.
Few fund managers do not focus on what others are buying but they focus on what looks good to them. They do not follow the herd and such strategies provide them decent return. Also, they do not get involved to do advertisements.
When a fund manager feels that they will not able to generate a good return if the fund becomes huge then they close the door for the new investors which restricts the fund to get huge by the additional flow of new investors.
We should also focus on the few points which can help while the exit from the investment of the fund such as an unexpected change in the strategy, increase in the expenses, sudden huge volatility to the returns, etc.
Few funds mentioned such a warning to the fund. I found PPFAS long term equity fund which has mentioned warning and to whom this fund is suitable and to whom it’s not.
Disclosure – Companies mentioned in the article are just for an example & educational purpose. It is not a buy/sell/ hold recommendation.
Read for more detail: The Intelligent Investor by Benjamin Graham, Jason Zweig