What to Ask your Fund Manager before Making a Change
According to Morningstar, close to 60% of US equity funds ran at a loss at the end of the first quarter. If you are one of these investors, you may be considering changing your fund manager. But before you make such a drastic decision, ask your manager three very important questions.
1. How long have you been responsible for the fund?
It is not wise to evaluate a fund’s track record if it’s just been taken over by a manager. It’s not likely that this will have an impact on your future results. Over half of the managers who have beaten the S&P 500 over the last five years have had tenures of at least five years. Three is the magic number. If you are paying a manager with less than at least three years of experience (preferably five), you are effectively paying someone to train with your money. Those who have been underperforming for the past five years should be the prime candidates for replacement.
2. How are you compensated?
Like anybody else, regardless of profession, fund managers need incentives. Although many believe that rewards should be based on performance, it also increases the risk of the manager taking bigger risks than what you should be comfortable with investing in the hope of bigger returns. It generally makes more sense for managers to be compensated for making good decisions, whether the fund loses money or not. There is often an option of avoiding loss by investing elsewhere and a good manager’s compensation will reflect their decisions.
3. What can you do in a bear market?
Because they require a minimum of 80% investment all of the time, most mutual funds can be challenging in a bear market. As much as 8% may be lost if the manager can only take 20% cash. Knowing when to turn defensive is one of the most valuable traits in a manager. By purchasing an inverse ETF for technology stocks, your fund can do better in a bear market. Technology funds don’t always allow managers to do this because ETFs are usually classified under the financial sector. It is important to find out if your manager is allowed to do this.
It should be acceptable that investors expect their fund managers to be skilled, take risks and know when to reduce their market exposure. If your fund manager hasn’t beaten the S&P 500 for more than five years and your fund lost money, you can probably do better.