The number of funds in the market today is higher than those of securities listed on the stock market. To the traditional investor this may seem disconcerting, but at the same time the growing number of investment solutions available represents a real opportunity.
The primary function of a fund is to gather a pool of securities so that the risk specifically attached to each security may be reduced thanks to the diversification involved. We can therefore consider these parts of the funds as low-volatility securities with the prospect of a more regular yield. With dynamic management, the constitution of a well-chosen pool of funds becomes a highly interesting investment.
The investor, however, may lose heart when confronted with the vast spectrum of investment funds available, and be at a loss as to the choices that need to be made. Key characteristics have to be scrutinised to evaluate a fund's quality. As far as quantitative returns are concerned, performance is just one of the many factors that need to be taken into consideration. It is the nature of the funds and the style of their management which direct the in-vestment as new situations arise. These are key factors.
The majority of funds can be tallied against an index. In this way the quality of the management can be assessed. A fund's objectives should not exceed the performance listed on the index. In the case of index funds, over-achievement by a few percent may signal a transgression of the fund's investment principles, and will raise questions concerning the management's stand vis a vis the general strategy.
The investor, on the other hand, may rightfully expect over-performance from an active management fund because the manager is able to make strategic wagers" in relation to his comparison index. An active manager who over-performs the index in every cycle of the market does not offer the investor any particular interest, and should be discarded to keep the management of the fund dynamic.
It can happen that active managements over-perform their index in some phases of the market and under-perform the same index in other phases. This observation leads us to consider that dynamic fund management or the monitoring of funds are the key to successful fund mangement.
To illustrate these propositions, we have presented two Swiss funds with well-known and distinct characteristcs, linked to the SPI index.
Fund 1 has for a long period relied on using options and futures to increase its performance. This was costly during the flat period but allowed the manager to profit from this "derivatory" approach, when the market picked up in 1993.
In 1994 the manager experiences a shock because the derivatives needed to increase performance also increase the drop in the market. The manager decides to change his investment policy and stop relying on options. His returns profile now becomes similar to that of fund 2, and diversification is no longer an asset in combining the two funds. In fact, fund 2 is almost an index fund, and therefore its profile performance, very close to the SPI index, makes it suitable, thanks to its experience in the field, to propose adequate management.
Dynamic management of funds requires knowledge of the characteristics of each fund to obtain a diversified and optimal combination without clashes in management styles.
Olivier Ferrari is managing director and an associate with Coninco in Vevey"