Morningstar Guide to Fund Investing

Introduction

My parents were half-way through their working life when they migrated to Australia from Sri Lanka. Once here, my father took a job as an aircraft engineer at Sydney Airport. Together my parents built a life and retirement for themselves from the ground up—a phenomenal endeavour of which I am very proud.

I was three years old when I first stepped foot in Sydney and have been given the enormous opportunity of a longer runway in Australia. But with that comes a heightened sense of awareness about what it takes to be self-sufficient in retirement. I have always been prudent in the way I use money—an invaluable trait inherited from my parents. And despite years at university spent poring over finance textbooks, what I was less sure about when starting out was how to get a leg-up.

Upon graduating, one of my first jobs was at a fund manager. And it was here that my respect for investing took root. I came into constant contact with financial advisers and investors who had put their trust in funds for decades—resulting in income streams that funded comfortable retirements. And unlike in the textbooks, I saw practical demonstrations of what investing for the long-term could do. This was something I had always sought: financial independence and self-sufficiency in retirement.

A well-worn proverb advisers like to use with their clients stuck with me: 'the best time to plant a tree was yesterday, the second best time is today'. Cliched perhaps, but this kernel of wisdom nevertheless helped me realise that if I were to succeed in being self-sufficient and comfortable in my retirement, I had to start now.

Managed funds provided me with a soft entry into the world of investing and I’ve relied on them throughout my journey. Not that I didn't give other investments a go. I experimented with direct equities but succumbed to over-trading. I monitored the market daily only to make rash decisions that I later regretted. Suddenly I realised I was ignoring the long-term horizon, making doubtful decisions, and creating work for myself.

Nor could I reasonably justify—or ignore—the brokerage fees that were eroding my capital. Much of my portfolio was also taken up by High Interest Savings Accounts (HISAs) and Term Deposits, which I quickly realised stood in the way of my goals. To these problems, funds provided me with an easy solution. I found them to be a convenient way to invest continuously; a place on which I could rely to make the hard decisions and do the paperwork; and ultimately, a way in which I could build the wealth that would allow me to live the life my parents had sought all those years ago. A life of self-sufficiency and comfort.

Given my personal experience investing in funds, I was excited to be asked to write the introduction to this guide. While funds may not provide the same advantages for everyone that I found, this guide explores the factors to consider when choosing a fund and where to go for the right information when it comes to deciding whether funds have a place in your portfolio. We hope you find it useful.

Shani Jayamanne
Morningstar Investment Management

What is a managed fund 

A managed fund (or mutual fund) is a pooled investment vehicle—it combines money from multiple investors and purchases assets chosen by a professional manager. Pooling funds with other investors allows you to access professional managers, who in turn can put your money in varying asset classes which may be difficult for you to invest in directly. This approach may also diversify your risk, for example, if one asset class dips another will be there to pick up the slack.

Managed funds: the pros and cons

A crucial benefit of managed funds is the ability to easily diversify your portfolio, alongside them being professionally managed and are convenient. However, there is both a lack of control and lack of visibility with funds, fees play a part and performance is not guaranteed. manage

Understand the full pros and cons of managed funds and walk through the many reasons why investing in these funds may help you achieve your financial goals in the full guide. Read it on Morningstar Investor.

What are you getting when you purchase units in a managed fund?

Most managed funds are structured as a unit trust. When you invest in a fund, you are purchasing units in a unit trust. Your investment in a fund will occur at a particular unit price, which denotes the value of the assets in the fund at the time of your investment. These units are priced by Net Asset Value (NAV), which is the per unit price of all the fund assets. These units are priced using the equation below—the net assets in the fund divided by the number  of units in the fund. The fund unit prices rise and fall according to market movements.

NAV = (Assets—Liabilities)/Total number of outstanding units

The full guide explores the other value you receive when you purchase units in a managed fund.

What to consider when investing in a managed fund

Does the fund meet your basic requirements?

Before considering a fund, you must first determine your eligibility and whether the fund will suit your investment objectives. There are a few key questions you should ask yourself. The answers to these questions can be found in the fund’s Product Disclosure Statement (PDS), or in the summary section of the Morningstar fund report.

Find the report and the full guide on Morningstar Investor.

Can less liquidity in funds actually help you achieve your goals?

How does the fund fit into your overall portfolio?

Take a step back and look at your portfolio and your existing investments. What are your objectives? Is your portfolio properly positioned to achieve your goals? To help you design a portfolio to meet your objectives in life, we have created the Morningstar Guide to Portfolio Construction. The guide shows you how to identify your goals and construct a portfolio that will help you meet them. 

If you are unsure where to start or how to answer these questions, Morningstar’s Portfolio X-Ray tool allows you to conduct in-depth analysis on your portfolio, including region and sector analysis. The portfolio X-ray includes a look-through feature that can drill into the individual holdings within the managed fund and provide a holistic view of how your total portfolio is allocated across asset classes, equity sectors, stock style (value vs growth and large cap vs small cap) and world regions.

How to tell a fund is right for you—process, style and fund mandates

Once you’ve identified what type of fund you need for your portfolio, the next step is to find funds that meet that criteria. However, it’s difficult to discuss process and fund mandates without exploring the debate between active and passive management. Both have the ability to add value to a holistic portfolio, but there are some intricacies to the debate that should be considered when deciding how (or if) to integrate funds into your investment portfolio.

That said, there are some key considerations when assessing active management.

1. Financial advice landscape in Australia - Approved Product Lists for Financial Advisers

2. Closet Indexing

3. The Impact of Fees

4. Do different asset classes lend themselves to different styles of investing?

Find the full section in our guide on Morningstar Investor.

Does the mandate align with your objectives?

Different fund managers use different methods of choosing the assets in the fund. It is important to understand whether the investment style and process aligns with your objectives and time horizon (how long you’re going to be invested in this fund).

Morningstar’s Style Box provides a graphical representation of the investment style of funds, classifying by market capitalisation and growth/value factors. If you are considering a fixed income fund, it classifies funds according to credit quality and sensitivity to changes in interest rates. This is also a data point that can give a truer indication of the investment style than the name of a fund, which does not necessarily correspond to the mandate or investment strategy.

Understand how you can utilise the Morningstar Style Box to assist with your investment strategy.

Performance

Valuable insights can be derived from examining a fund’s performance. That said, putting too much emphasis on a fund’s performance and basing buy and sell decisions on recent performance is a recipe for under performance. 

There are many risk measures that will help you understand a fund’s suitability in your portfolio. The risk measures can be found in Morningstar Fund Reports, summarised in the Performance section.

Find the risk measures in the full guide or in the Morningstar Fund Reports on Morningstar investor.

Although these measures can be indicators of levels of risk in a portfolio (and in turn, the context of the performance), they are not ultimate indicators of the success or failure of a managed fund. They are considerations that Morningstar analysts use to contribute to how they view the fund, but much of the context is given from direct contact with fund managers and analysts who make the decisions and direct strategy. This includes looking at other funds that the team may manage or used to manage in the past.

People

A manager is flanked by a team of analysts, traders and other professionals who contribute to the decisions made on a managed fund. Although individual investors traditionally have no access to the people making decisions on their investments, Morningstar considers all involved when issuing a rating on the fund. It’s important to consider their expertise, experience, perceived stability (is there a lot of turnover in the team?) and skill—and how it stacks up against others in their weight division.

Price

This section goes through the considerations and questions you should ask, as well as the types of fees associated with funds, and finally how to invest in managed funds. 

Read the full guide to Fund Investing on Morningstar Investor to explore this in detail.

How do I invest in a managed fund?

There are a few ways to invest in a managed fund. Find out how to access managed funds in our full guide.

How does Morningstar rate funds?

Morningstar has a network of more than 110 manager research analysts located across the firm’s offices in Sydney, Chicago, London, and Hong Kong. In Sydney, our team of more than 10 manager research analysts have more than a decade of experience on average. These analysts share global insights, analysis, and investment data.
Our manager research team is responsible for rating funds using the qualitative Morningstar Analyst Rating. The Morningstar Analyst Rating is the summary of our forward-looking view of a fund. It is the outcome of a collaborative process based on a site visit, manager questionnaire, quantitative and holdings-based analysis of the portfolio, and an assessment of key issues identified by our analysts.

Morningstar’s qualitative manager research aims to determine which investments deserve the attention of investors and which do not. Morningstar assesses investment managers based on how we believe they will perform in the future over an economic cycle, against both peers and accepted benchmarks. Our model rewards managers that are open and transparent, have a well-run investment process and, importantly, are good fiduciaries of investors’ monies.

We have identified five areas we believe are crucial to predicting the future success of funds: People, Parent, Process, Performance, and Price. Based on our evaluation of these components, our analysts assign a Morningstar Analyst Rating to funds using a five-point scale ranging from ’Gold’ to ‘Negative’. The top three ratings of Gold, Silver, and Bronze all indicate that our analysts think highly of a fund; the difference between them corresponds to differences in the level of analyst conviction in a fund’s ability to outperform its benchmark and peers through time, within the context of the level of risk taken.

The Analyst Rating does not express a view on a given asset class or peer group; rather, it seeks to evaluate each fund within the context of its objective, an appropriate benchmark, and peer group.

Morningstar rates funds by using five pillars:

1. People How talented are the fund's managers and analysts? Do the experience and resources match the strategy?
2. Process What is the fund's strategy and does management have a competitive advantage enabling it to execute the process well and consistently over time?
3. Performance Is the fund's performance pattern logical given its process? Has the fund earned its keep with strong risk-adjusted returns over relevant time periods?
4. Parent What priorities prevail at the firm? Stewardship or salesmanship?
5. Price Is the fund a good value proposition compared with similar funds sold through similar channels?

Resources to help you identify funds to invest in

Our analysts interview portfolio managers, analysts, executives and staff who have a direct or indirect influence on the decision-making process of the fund. There are a few sections in the fund report that can help you determine whether it’s going to suit your portfolio.

Morningstar offers a summarised section at the beginning of each report, outlining our analysts’ stance on the five pillars, and the medallist rating (if any). Fund ratings can range from Negative to Gold.

As mentioned previously, the Equity Style Box allows you to see where the fund is investing, and the types of investments they are generally making in the fund. Our equity region exposure chart also allows you to see the regions the fund is investing in—this should be considered against your existing holdings in your portfolio (if any) to ensure there is no unintentional overexposure to particular regions. The sectors are covered in the asset allocation section. Using these factors, investors can determine whether the fund is suitable for their portfolio, and whether it is in turn helping them reach their goals.