5 tips for evaluating new investment funds

Since 2000, over 7000 new funds have launched in Australia and New Zealand with varying levels of success.

With this many new products touting their wares, investors need a way to evaluate them without falling victim to slick marketing.

Morningstar’s manager research teams across Asia collaborated on a series of country-specific reports to help investors navigate today’s complex investment landscape and weigh up new offerings.

This article shares five insights from this research, and five key questions that the analysts behind this research have encouraged investors to ask.

Seek a differentiated offering

Investors that choose active funds stump up higher fees for the possibility (and no guarantee) of outperformance versus the benchmark.

The report encourages investors to weigh up how likely this outperformance is to materialise and whether the payment of higher fees is likely to pay off. But how can they do this for new funds that don’t have a track record?

This, of course, is not easy. But one thing that investors should consider is whether the new fund offers a genuine point of difference versus what’s already available.

Why invest in a fund that is doing something very similar to established funds in its category, only without the track record of results and actions? Investors can also look at how other strategies in the category have performed over time.

“If most funds in a category have struggled to beat their benchmark” the paper’s authors say, “it may suggest that the segment has become more efficient, making it harder for active strategies to stand out.”

In such cases, a low-cost passive fund could be more attractive. If you are going to pay more in fees, you should be looking to invest in a fund that offers 1) something different and 2) a reasonable chance of outperformance.

Put your long-term goals over short-term hype

The reality is that most investors and most investment products have different objectives. And let’s not forget - the goal of many, if not most, funds is simple: they want to attract the most assets and generate as much fees as possible.

The easiest way for them to attract assets is to launch products with strategies that are currently in vogue. Often in an asset class or investing theme that has strong recent returns and future prospects that investors are excited about.

But instead of falling for hype, fund investors should try to remain focused on their long-term goals.

Broad based equity funds, for example, are often the best for goals related to long-term capital growth, while income-oriented goals are often better served through – you guessed it – vanilla fixed income or dividend-focused equity funds.

This isn’t rocket science and it isn’t as exciting as investing in the asset class du jour. But that might be the point.

“Very niche fund offerings built around hot trends tend to falter when the initial excitement fades” says Shamir Popat, a Senior Analyst at Morningstar Australia who contributed to the report. “This can lead to disappointment”.

The report references what Popat calls “sobering” data from Morningstar’s 2024 Global Thematic Funds Landscape report. In the past 15 years, over 60% of thematic funds that were opened have since shut down. Often due to poor performance.

Figure 1: Global thematic fund performance and closures over different time periods. Source: Morningstar

Despite this, the report pinpoints that not all thematic funds are the same. There is a big difference between funds built purely to “ride a short-term wave” than those supported by genuine long-term tailwinds such as demographic shifts.

The paper also highlights that diversified equity options, including global index funds, can provide a level of exposure to themes like this without being fully dependent on a single thematic for success.

Look for relevant experience and consistency

An investment fund is only going to perform as well as the people running it. As a result, weighing up the experience and investing approach of your potential fund manager is an important step in any evaluation.

Most fund managers will have managed another fund beforehand and many tools (including Morningstar’s) will show you their track record. Where they have been, how long they stayed, and how they performed.

What investors should seek in a manager is clear domain expertise. Not just in the fund’s asset class or category but in managing money towards similar investment objectives as those targeted by the new fund.

The paper also recommends going beyond the numbers by using Google to surface old interviews, presentations and fund commentaries. This helps investors understand how the manager thinks about investing and how their past promises and actions match up.

Get a feel for how the portfolio will be run

Having a clear idea of how the portfolio is likely to managed is vital in having the right expectations, the report shows.

The new fund’s Product Disclosure Statement should signal whether it will be concentrated or diversified, how frequently holdings are likely to be traded, and how much flexibility the manager will have when it comes to asset allocation decisions.

On the latter point, an equities manager might have limits on how much cash can be held in the portfolio or in which regions they can own shares. Or in fixed income, they could have varying amounts of freedom to invest in different grades or quality of debt.

While there are no right or wrong answers here, it is vital to know what you signing up for in advance. Especially in regards to the potential merits and risks of different approaches.

A highly concentrated approach, for example, could increase the likelihood of a fund posting more volatile returns and delivering results that differ significantly – happily or otherwise – from the benchmark.

Going through this exercise will allow you to compare the fund’s promises on these fronts to how the fund is actually being managed.

Don’t forget the impact of fees

Investors will often be sold on the quality of insight and investing prowess that a fund’s investment team can bring to the table.

While this can be true in some cases, there is no denying that higher fees raise the hurdle for a good total return. After all, they come straight out of the total return than an investor receives on their investment.

Morningstar research in the past has shown that low-fee options consistently post higher success rates (versus their benchmark) and survival rates. The report also underlines how vital it is to consider the impact of performance fees if they apply.

Figure 2: Lowest cost funds have outperformed higher price options in most fund categories. Source: Morningstar

The key message? Investors should be reluctant to sign up for high fees relative to other options in the asset class.

As we covered earlier, they should only be willing to do so if the fund offers something genuinely different with a reasonable chance of success.

Five questions to ask about new funds

The report concluded with a useful list of questions investors should seek to answer about any new fund. They were:

Is the fund built on a sound investment rationale, or is it chasing a trend?
Does it bring something new to the table, or simply crowd into an already packed space?
Are the people behind it experienced in managing similar strategies?
How do they communicate what they’re trying to achieve and how they’ll manage the risks?
Are the fees charged competitive relative to what the fund aims to offer?

Morningstar Investor members can learn more by reading the full “Buyer Beware - Australasia Edition” report here.