7th January 2011

7im: A Difficult Choice?

News has reached me that Justin Urquhart Stewart – the proficient author of this column - is safely tucked up in bed, albeit unable to travel very far, and possessing a myriad of technologies via which to communicate to the outside world. Where once upon a Dickensian time, Justin would’ve maybe had to resort to a carrier pigeon or two, he can now choose to surf, chat, email, phone, text, tweet or take over the airwaves to make himself heard.

But the selection of the medium through which to communicate isn’t always an easy one, as aptly conveyed by Drew Barrymore’s character in a recent rom-com when she despairs to her friend “I had this guy leave me a voicemail at work, so I called him at home, and then he emailed me to my BlackBerry, and so I texted to his cell, and now you just have to go around checking all these different portals just to get rejected by seven different technologies.”

A recent article in the Economist talks about exactly this problem, the drawback of having too much choice. There are examples aplenty in the column from the sheer maddening range of crisp flavours, the different varieties of Tropicana juices, to plastic surgery options. This predicament can’t be all that hard to relate to, particularly for those of you who have been employed in the job of Christmas present shopping. Looking to gift someone a mobile phone? Look to be confounded by the utter choice of payment plans, service providers and handsets. Thinking of buying some wine to go with your Christmas meal? Think through red, white or pink? Sparkling or not? Chile, Italy, New Zealand, Californian or a French grape? The choices are seemingly endless.

Arguably choice has improved our lives immeasurably, and free choice is what drives markets, competition and economic growth. Whilst the Economist article prefaces by admitting that the increase in choice is “testimony to human ingenuity and innovation”, it goes on to argue that too much choice is demotivating, or can prompt panic and a failure to choose at all.

What the article doesn’t cover is this quandary from an investment standpoint. According to Blackrock there are 2,422 ETFs available for investment worldwide. Rabbits have multiplied slower than the mushrooming of ETFs that has occurred in the past year. The Investment Management Association (IMA) reports there to be around 2,500 mutual funds for sale in the UK.

At 7IM, we recognise that a large array of funds gives us the opportunity to provide our investors with the cornerstone of our investment philosophy – diversification. But our risk-adjusted diversified portfolios also recognise that there are an optimal number of funds to hold within a portfolio. Choosing to hold more is not advantageous as the incremental benefits of diversification diminish after this optimal point.

Back to the mind-boggling assortment of 2,500 funds; how do you as a retail investor even begin to choose? At some point (presumably around the 100 mark?) the effort needed to obtain enough information to distinguish between alternative funds outweighs the benefit of extra choice. 

So how do you try and sort the wheat from the chaff? Price-comparison sites such as moneysupermarket.com have made a business from guiding consumers through the maze of credit card or mortgage options. Ironically, even the choice of price-comparison sites to help people choose is expanding. The IMA helpfully break down the mutual fund world into sub sectors ranging from income or capital growth to type of asset, region or industry. Investors can then compare funds in one or more sectors before looking at detail individual funds to make their investment decisions. Rating companies like Morningstar also play a key role in evaluating mutual funds. A four or five star rating may make it easier to choose outperforming managers.

There is one thing that makes selecting between your options easier. That is the power of the brand. Ever since the 19th century, when Coca-Cola began to sell a carbonated drink of questionable colour, claiming to cure dyspepsia, neuasthenia, headache and impotence, to Americans and the rest of the world, companies have promoted their brands to make consumer driven lives “easier”.

There’s no doubting that brands simplify choice. However in the world of mutual funds, following a brand may not be the most prudent of decisions. The tale of the recently demised New Star Asset Management Group – one of the highest profile names in the industry, should prove a sound warning. The debt ridden company was eventually bailed out by Henderson and the New Star name was finally snuffed out earlier this year. The newly renamed Henderson funds will be similar sounding to other previously existing Henderson funds in some sectors like Technology. As if you weren’t confused enough already! The amalgamation of the two asset management companies may lead to mergers of some funds in the future.

It is important not to fall for the billboards you see waiting for the train or the fancy marketing gimmicks employed by some asset management companies. The understanding of the investment process is imperative whilst assessing funds for your portfolio. The literature of any fund should always be read. What is suitable for you depends on personal circumstances and not merely the sector classification or rating. Lastly, evaluate managers on not just their recent performance. Rather than reading too much into last year’s performance, try and find funds that have low turnover and long manager tenure, investments that have trustworthiness, conviction, communication, transparency, governance structures and process. Buying funds that have invested in good personnel, research and risk safeguards are what will help you get value for money over the long term.

And remember... if you choose not to decide, you still have made a choice.

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And finally….. If your children haven’t quite met their appraisal targets during the year then you could always use the time honoured threat that Father Christmas won’t be paying them a visit unless they are especially good and go to sleep early on Christmas Eve but, if you feel the need to go a step further then perhaps you should consider relocating to Hungary where the locals take a rather stricter line when it comes to child discipline.  Over in Budapest Santa’s evil counterpart is Krampus, who makes it his business to punish small people who made the “naughty list” by chaining them into a basket and carrying them off to the underworld.  And to think that the best we can come up with is to try to force-feed the little ones to eat an over-boiled sprout!

I wish you all a very merry Christmas and a happy New Year. See you in 2011!

Aparna Ram
Investment Analyst
Seven Investment Management

Investments