Best practice for fund selection and monitoring

Parts of the fund management industry are facing a turbulent time. While some have taken this as a sign of the inherent flaws in active management, we believe it should instead serve to illuminate best practice in the selection and ongoing monitoring of funds. In particular, it should finally lay to rest the idea that selecting funds is just about finding a manager with a good track record and sticking to them like glue.

Investors need regular contact with the fund manager to discuss any problems openly and honestly. Dealing with a difficult situation can be resource-intensive and may require daily monitoring. It helps to have ready access to the fund manager to discuss concerns and formulate a solution.

Recent events serve to highlight a number of under-the-radar elements of fund selection and monitoring. These elements may seem like a side-show for much of the time, but recent developments in the industry have shown how important they can be at certain moments in preventing losses for clients.


Portfolio liquidity is not a key concern for most funds. However, when it becomes an issue, it can have a profound effect on performance and may even prevent unitholders temporarily getting their money back in the short term.

In selecting investments, we always consider whether the liquidity of a fund's portfolio matches the liquidity being offered to unitholders. To our mind, open-ended funds with daily dealing should not be holding illiquid assets. Investment companies are more robust vehicles for areas such as private equity, infrastructure or commercial property. While the discount on an investment company may widen due to selling, investors can still get their capital back, but most importantly the manager is not a forced seller of the assets in the portfolio for this to occur. This is critical for ongoing shareholders who are in for the long-term and willing to ride out short-term price volatility.

With this in mind, we believe our having expertise in closed-ended funds is a real advantage. It means that investors can get access to these illiquid assets – some of which offer real diversification and growth potential – but without some of the associated risks.

Equally, it is worth bearing in mind that liquidity is not static – it can change as an asset class falls in and out of favour. Liquidity will often dry up in a bear market. As such, it's important to monitor it regularly. We are yet to see a sustained fall in markets since the Global Financial Crisis, but when one does invariably occur, we believe that liquidity in all areas, from sovereign bonds to emerging market equities, will be tested due to lower liquidity on bank trading books.

Fund flows

Fund flows, both in and out of a fund, can change the make-up of a portfolio. Significant inflows can force managers to compromise their investment process, buying companies that they wouldn't otherwise. Outflows can force them to sell their most popular and liquid holdings, leaving a rump of less liquid or underperforming assets. In both cases, fund managers aren't buying and selling based on those stocks in which they have most conviction. This can create style drift and introduce unwelcome skews into a portfolio.

Equally, fund managers with significant inflows or outflows may find that the market starts to conspire against them. Hedge funds may short stocks in their portfolio, leaving them selling under pressure and exaggerating the falls in their portfolio. Alternatively, those with inflows may find the shares they want to buy are bid up, leaving them paying a higher price.

We are always alert to significant changes in fund size and also of the concentration of unitholders in a specific fund. If a fund has a number of large unitholders, it can be vulnerable to them withdrawing their holding.

Access matters

Investors need regular contact with the fund manager to discuss any problems openly and honestly. Dealing with a difficult situation can be resource-intensive and may require daily monitoring. It helps to have ready access to the fund manager to discuss concerns and formulate a solution.

We value an open dialogue with fund managers, looking at the team dynamic and considering how they interact with their compliance function. We believe that understanding these elements of a fund manager's process and resources, leads to better judgements.

Proprietary research

It is easy to get swept along with a popular manager, however, our view is that you need to do your own research and have independence of thought. This means that we have the flexibility to adjust our asset allocation or holdings when the situation changes and are not reliant on industry ratings on funds which are often backward looking.

This type of intensive research and monitoring of funds can be difficult and time consuming if you are also meeting the day to day demands of clients. It is our belief that the outsourcing model will go some way to circumventing the high-profile problems seen in the fund management sector whilst instilling confidence in the adviser market that there is a robust and repeatable investment process which they can access on behalf of their clients.

For further information, please contact Mickey Morrissey, Head of Distribution

t: 020 7131 4693

Important information

By necessity, this briefing can only provide a short overview and it is essential to seek professional advice before applying the contents of this article. No responsibility can be taken for any loss arising from action taken or refrained from on the basis of this publication. Details correct at time of writing.

Investment does involve risk. The value of investments and the income from them can go down as well as up. The investor may not receive back, in total, the original amount invested. Past performance is not a guide to future performance. Rates of tax are those prevailing at the time and are subject to change without notice. Clients should always seek appropriate advice from their financial adviser before committing funds for investment. When investments are made in overseas securities, movements in exchange rates may have an effect on the value of that investment. The effect may be favourable or unfavourable.

Smith & Williamson Investment Management LLP is part of the Smith & Williamson group. Smith & Williamson Investment Management LLP is authorised and regulated by the Financial Conduct Authority.