So just what kind of funds should you invest in and how can you find them? Read on to find out.
Core UK Equity Exposure
If you are a younger investor, you have the luxury of time. With a long investment horizon, you have the time to absorb losses and can therefore take on more risk. With that in mind, focus on stock funds
(as opposed to bond funds, which offer more stability but a lot less return potential). At first, it’s best to avoid highly-specialised niche funds, such as those focused on particular industries or individual countries. You really want to build a broadly diversified portfolio, with domestic large-cap stocks making up the core of your portfolio. The world doesn’t end at the water’s edge, however, and you don’t want to put all your eggs in one basket. So you should make sure you have exposure to global markets too.
When choosing a large-cap stock fund, an index fund that captures your domestic market can be a good option. Funds tracking the FTSE All-Share index give you exposure to the entire UK market all in one swoop, albeit with an emphasis on large-cap, FTSE 100 shares. These funds’ lone job is track the index, saving you the worry of who’s running the show -- an advantage for a young investor who wants to keep it simple -- but also at a typically lower cost than an actively-managed alternative. For example, the total expense ratio of the average actively- managed fund in the UK Large-Cap Blend Equity category clocks-in at 1.44%, compared with 0.73% for an index fund. Index funds’ inherent cost advantage makes it likely they’ll be able to beat their rivals. Nevertheless, some broad active funds can offer similar advantages and do the job well too, but these require more homework because you have to look beyond past performance and understand the investment process and people behind the fund. We can help you do exactly that with our own analysis. Click here to review our take on funds we've covered so far.
Finding Potential Winners
Of course, it doesn’t do you any good to know what you should own if you don’t have the money to invest in them. Fortunately, many funds feature minimum initial investments as low as £100. You want to keep other factors in mind too, especially fund costs. Fund expenses are among the best predictors of long-term performance, so funds with low expense ratios give you a big advantage.
A good starting point for first timers is Morningstar’s Fund Screener tool. You can use it to winnow out funds with high initial investments, high costs, and narrow mandates. To pick a core UK offering, I used fund screener to find UK domiciled funds within the UK Large-Cap Blend Equity category with minimum initial investments at £500 or below, total expense ratios below 1.0% and with at least three stars. One fund that passes this screen, Fidelity's MoneyBuilder UK Index fund, shines as a suitable pick. The fund tracks the FTSE All Share index and has outperformed its average category peer (including other trackers and those actively managed of course) over the last three, five and ten years annualised, while also providing a relatively smoother ride. What is more, the fund boasts a 0.28% expense ratio, more than a full percentage point below the category average.
But it's unwise to put all your eggs in one market basket. To add diversification, you could pair your UK fund with a one featuring a global mandate. To do this, you can again use Morningstar’s Fund Screener . This time, you could screen for Global Large-Cap Blend Equity funds with a minimum required investment of £500 or less and an expense ratio that is below 2% (I have increased the expense hurdle for global funds as these are generally pricier than domestic funds).
M&G's International Growth fund pops-up here as an appealing choice. Its skipper, Greg Aldridge, emphasises international markets by formally excluding UK issues, making the fund a better diversifier. Aldridge became deputy-manager on the fund in 2006, working alongside M&G's 19-year veteran Graham French before taking the helm a year later. The fund has amassed a competitive risk/reward profile, outpacing 98% of its peers over the last five years with a 20.5% annualised return , and we think head of equities David Jane has done a very good job of sharpening M&G's approach to research and portfolio management.