What to check before investing in a managed fund

If you’re looking for a better return on your money, ads for managed funds – promising returns as high as seven percent – can make them seem an easy option.

But don’t start planning how you’ll spend those juicy returns just yet. Before you call the fund manager, there are a few key things you should check.

What is a managed fund?

A managed fund, such as KiwiSaver, pools money from investors and can be put into different asset types such as shares, property, bonds or cash. Funds are run by managers who make their money charging fees, which can vary widely.

There are five main types of funds: defensive, conservative, balanced, growth and aggressive. All investments have risk but growth and aggressive funds tend to have the highest levels. In theory, the riskier the fund, the greater the reward over the long term, although that doesn’t always work out to be the case.

You should identify the level of risk you’re willing to take on before considering investing. For example, your appetite for risk might be lower if you’re five years away from retiring, compared with someone just starting out in the workforce.

Managed funds are regulated investments, which means they are monitored by the Financial Markets Authority (FMA). The FMA licenses fund managers and checks that they’re complying with the law.

Do your reading

All managed funds have some must-read documentation for would-be investors.

• Product disclosure statement (PDS): A fund’s PDS should be first on your reading list. It’ll explain how the fund works, including its likely risks and returns, as well as fees and charges. The statement also details the fund’s investments and the fund manager. You can find the PDS for any managed fund via the Disclose Register.
• Fund updates: Published quarterly, these updates let you know how the fund is performing compared with a selected benchmark (for example, a market index). Updates also have other information, such as the fees the fund has charged to investors.
• Annual report: This shows how a managed fund has performed against its goals. It might also include information about changes, such as a new fund manager.
• Statement of investment policy and objectives (SIPO): This sets out who runs the managed fund and how they do it. The SIPO should include any disclosures to do with ethical or responsible investing.

Tip: It can be a red flag if a fund often changes managers.

The finer details

When you’re researching a fund:

• Check the fine print: Ads for managed funds tout attractive returns – “7% year-on-year return*”. Follow the asterisk and you’ll find fine print along the lines of “*Based on historical performance”. A golden rule of investing is that past returns are not indicative of future performance.
• Add up the fees: Fees eat into your returns. Take a fund charging 3.75 percent per annum in management and administration fees. If you invested $10,000, you’d pay $375 a year in fees. You can also be charged if you withdraw money early. If you’re unsure what you’ll be up for, ask the fund manager to explain the fees in plain English.
• Understand net return: That’s what you’ll get back after fees and taxes are taken out.
• Review past performance: Check the fund’s returns for at least three years, but ideally 10 or more. It’s not a guarantee a fund will continue to perform well but indicates how well a fund weathers the highs and lows of market volatility.

Tip: Sorted Smart Investor provides a snapshot of risk levels, fees, returns and other information for 409 managed funds.

Ethical investment

If you’re looking for an ethically managed fund, you’ll need to do extra digging.

There’s no standard definition of “ethical” or “responsible” investment – and what the fund manager considers A-okay may not pass muster with you.

Most funds claiming to offer ethical investment use “negative screening”, an approach that excludes investment in specific sectors – for example, tobacco or other “sin” stocks.

If a managed fund is making ethical claims, it should be upfront with you about its investment approach and what it’s doing to deliver on advertised outcomes. You should expect to get regular reports on progress.

All managed funds must list their top 10 holdings in their quarterly fund updates. To do a deeper dive, you can find a list of the fund’s full portfolio holdings on the Disclose Register. Funds are required to file returns every six months.

If a company makes misleading ethical investment claims, it could find itself taken to court by the FMA. The FMA’s powers also include issuing a stop order. A business failing to comply with a stop order can be fined of up to $300,000.

Jargon buster

• Active management: An investment strategy that actively chooses and trades investments to outperform the market. It typically costs more than passive management.
• Diversification: This is where you mix your investments across asset classes. This can help protect your money by spreading risk.
• Exchange traded fund (ETF): An ETF is a type of managed fund. It’s comprised of a “basket” of investments (usually shares, bonds, commodities or currencies). It usually tracks a market index and therefore is a passive investment, which means its fees tend to be lower than actively managed funds. You can buy into an ETF the same way you would buy shares.
• Index: This is a measure of how a selected portion of a share market is performing. New Zealand's S&P/NZX50 is an example of an index (the number is how many companies are in the index).
• Index funds: A fund that buys and holds shares in the index it’s tracking.
• Passive management: An investment strategy typically based on investing in market leaders.