Fund Selection Process

Question 1

What is the Fund Selection & Adviser Independence process?

Answer 1

1. Fund selection occurs after asset allocation.
2. Advisers may be tied to a provider (limited selection) or independent (access to the whole market).
3. However wide or narrow the choice is, certain factors should still be taken into account as part of the fund selection process

Question 2

Define fund charges?

Answer 2

1. Fund charges reduce overall investment returns, making it crucial to understand all costs involved.
2. Transparency is often lacking, and investors may not always see the full cost breakdown.

Question 3

What are the two main types of fund charges?

Answer 3

1. One-off charges:
   A. Applied at the point of sale and/or exit (e.g., within the first five years).
   B. This can also include the fee paid for investment advice if advice is obtained.
2. Ongoing charges:
   A. Run through throughout the life of the investment.
   B. Includes:
   I. investment management - management of the fund
   II. administration fees - charged by the fund provider
   III. platform costs - when the fund is administered by a fund platform
   C. Some fund providers quote an annual management charge (AMC)
   D. These charges reduce long-term returns.

Question 4

What are some Key Charge Metrics for a fund other than the one-off and ongoing charges?

Answer 4

1. Annual Management Charge (AMC):
2. Ongoing Charges Figure (OCF):
3. Trading Costs:
4. Platform Fees:
5. Performance Fees:

Question 5

What is the ongoing annual management charge (AMC)?

Answer 5

Charge that covers the fund manager’s research, analysis, and portfolio management.

Question 6

What is the ongoing charges figure (OCF)?

Answer 6

A. Replaced the Total Expenses Ratio (TER).

B. Represents the total recurring costs of running the fund.

C. Includes AMC plus other administrative fees.

D. Paid annually

E. OCF must be displayed in the key investor information document (KIID) of a unit trust or OEIC

Question 7

What are trading costs?

Answer 7

Additional charges for buying and selling assets within the fund, including:

I. Broker commissions.
II. Stamp duty (especially for UK equities).

Question 8

What are platform fees?

Answer 8

A. Charged by platforms or stockbrokers to hold investments.

B. Either a percentage of investments (0.30%–0.45%) OR,

C. A flat fee (£80–£100 per year).

Question 9

What are performance fees?

Answer 9

Some funds charge extra for exceeding performance benchmarks or meeting particular targets

Question 10

What is the effect of ongoing charges on the fund’s performance?

Answer 10

1. Higher charges create a bigger hurdle for a fund to outperform competitors.
2. Typical ongoing charges for:
   A. Actively managed funds: 0.75%–1.50%
   B. Tracker funds: As low as 0.15%

Question 11

What are the Regulatory Transparency Requirements under Markets in Financial Instruments Directive (MiFID II) for funds?

Answer 11

1. Requires investment managers to disclose all transaction costs separately from OCF.
2. Independent Financial Advisers (IFAs) must report all costs to clients.
3. This led to greater transparency, revealing that total costs are often much higher than OCF, especially for active funds.

Question 12

What are the three main considerations in the investment selection process?

Answer 12

1. Financial stability of the fund provider.
2. Past performance of the fund manager.
3. Due diligence and fund selection.

Question 13

For each of the considerations in the investment selection process - expand on each of them and why is it important?

1. Financial stability of the fund provider.

Answer 13

1. Importance of Stability
   A. A fund provider’s financial stability is crucial for protecting investors’ assets.
   B. Hedge fund failures and liquidity issues with property funds also pose risks.
2. Liquidity in Property Funds
   A. Open-ended funds investing in property can face liquidity problems when many investors attempt to redeem their shares during market downturns.
   B. If the fund holds physical property (which is hard to sell quickly), it might need to maintain large cash reserves, which may not always be sufficient during mass redemption requests, causing temporary fund closures (e.g., during Brexit and COVID-19).

Question 14

For each of the considerations in the investment selection process - expand on each of them and why is it important?

2. Past performance.

Answer 14

1. Indicator of Manager Skill?
   A. Past performance is often considered as an indicator of a fund manager’s skill, especially when compared to sector averages.
2. The assumption is that managers who performed well last year are likely to perform well again.
3. FCA Warning:
   Past performance is NOT a reliable indicator of future performance, and appropriate risk warnings must be given to clients.

Question 15

For each of the considerations in the investment selection process - expand on each of them and why is it important?

3. Due diligence in fund selection.

Answer 15

1. Stability and Independence of Service Providers
   A. Conducting thorough due diligence is crucial to assess the stability, independence, and standing of service providers like fund trustees, custodians, and auditors.
2. The Madoff Ponzi scheme is an example of why due diligence is essential
   A. Existing investors were paid from new money coming in.
3. Warning indicator:
   when management, execution and custody of assets/ trades are all performed internally - there high risk of performance manipulation and misappropriation of assets