Types of funds and how to choose one

Investors can choose from many different types of actively managed mutual fund, as well as index funds and ETFs. With so much choice it’s important to consider what you want from an investment and do your research. We cover some basics here.

When selecting an investment fund, the world is your oyster with many different types of funds to choose from. However, this wealth of choice often isn’t very helpful, given that most people only want one or two funds that will do a good job without them having to think too hard. There are thousands and thousands of investment funds, covering every possible investment preference. How can you find the right one for you?

It’s worth starting by asking what you want from your investment. It may be that you just want it to grow as much as possible in as short a time as possible and don’t mind if the capital value bounces around. If this is the case, you should consider yourself a growth investor.

Alternatively, investors may turn to the stock market for income given the low returns on cash. In aggregate, dividends from the UK stock market tend to deliver around 3.5%,

significantly higher than the income available on a savings account. There are income funds that aim to blend the best dividend paying companies.

If you’re very nervous about any fluctuations in the value of your investments, but are worried about the low returns on cash, or the effect of inflation, you can probably characterise yourself as a cautious investor. This may lead you to investments with greater capital protection such as blue chip equities or developed market bonds.

Much will depend on your time frame. In general, if you have five years or more to invest, you can take a greater risk on stock market investments. The longer you have, the more risk you can take. This means you may want to explore long-term themes, such as technology clean energy or the rise of emerging markets 

• Stock market-based investment funds are still largely organised and measured on geographic lines. The major Investment Association sectors are UK All Companies, Global, North America, Europe ex UK, Asia and Emerging Markets. Funds will be grouped together and compared according to their region. If you’re agnostic on where to invest, you may want to consider a global fund, where the fund manager will make those decisions for you.
• Bond funds tend to be organised on risk lines. Investors can go for government bonds, which are low risk, low return, up to high yield, which tend to be focused on higher risk companies. Other options include commercial property, multi-asset funds (which combine lots of different asset classes) and ESG (environmental, social and governance focused investments) or sustainability options.
• Hedge funds are a particular type of mutual fund. They take a much higher level of risk with the aim of achieving higher returns and so are aimed at professional investors only.

Another important choice for investors will be whether they opt for an index fund versus an actively managed mutual fund. 

An index fund, of which an exchange traded fund (ETF) is one particular type, simply aims to replicate an index such as the FTSE 100 or S&P 500, rather than having a fund manager selecting individual companies. Index funds are often cheaper, but active fund managers may have more flexibility to adapt to different market conditions.

The Financial Conduct Authority is clear that past performance is not a guide to the future. Certainly, there are lots of reasons why past performance may not recur – a change of manager, fund size or a change in market conditions. History is littered with fund managers who have been heroes, only to lose their touch. Neil Woodford, for example, delivered strong performance during his time at Invesco, but could not replicate it when he started his own company.

Some fund managers – such as Nick Train at Lindsell Train, James Anderson at Scottish Mortgage and Terry Smith at Fundsmith – have delivered strong returns over many years. All of them have had periods when they have been out of favour or their style has struggled, but they have come back strongly. It is always worth knowing how performance was achieved, and whether the same circumstances are still in place.

They will usually ask questions about risk tolerance, growth aspirations and for how long you want to invest. They may also have preferred fund lists that help you navigate individual fund sectors. Fund analysis groups such as Morningstar or Trustnet will also have rated funds. Using these tools, investors can screen on the metrics that are most important to them, whether that is sustainability considerations, volatility, or performance.

It is always worth doing some homework. The factsheet for individual funds will have details of the top 10 holdings. This can indicate whether these are the type of companies you want to invest in or not. Charges shouldn’t be the sole consideration when buying a fund, but it is useful to see how a fund stacks up against its peers. Most importantly, you don’t want to be paying active fees for a fund that looks very similar to an index, such as the FTSE 100 or S&P 500.

Fineco has a selection of the world’s top-rated funds from the best fund managers, along with tools and resources to help you choose the right types of fund for you.