Investment: Truth's in the eye of the fund holder

IN LIFE, as we all know, there are lies, damned lies and statistics. In the fund management business, there is performance, damned good performance and unbelievably good performance, at least if you judge the business by the figures they put in their advertisements.

Pinning down what constitutes really good performance in an investment fund is as tricky as catching a bar of soap in the bath. Performance is an immensely malleable concept, and the marketing departments of unit trust companies in particular are past masters at producing figures that look more impressive than they really are.

Unit trusts, like insurance, are sold, not bought. For that reason alone, it is no surprise that investors put the bulk of their ISA money so far this year into non-CAT standard funds, where most fund management companies are concentrating their marketing effort.

To be fair, the pitfalls for any investor stepping out to buy a unit trust are legion. Past performance being no guide to the future, the rubric the regulators rightly insist on is included in prominent print in all advertisements for equity-based funds. Nor is it solely the fact that most figures quoted are somewhat economical with the actualite of what a fund is going to cost you.

For that you have to look at the size of the bid-offer spread, the basis on which the prices are quoted (bid to bid, offer to bid, you name it), the annual management charge and other costs. Then you need to look at the illustrative projections in the documents you are sent by the unit trust company to find out how much money you might get back on various assumptions (research suggests many people never even get that far). And all this process, of course, is before you make what is the most important decision, which is where to put your money. This is more than one decision. Part of the process includes which fund management company and which fund to choose. Partly, it is about choosing a trade-off between risk and return that suits your circumstances and temperament. But most important of all, over the long run, is the asset allocation decision about which country and which markets you decide to invest in.

The trouble is that the figures quoted in the advertisements for the funds you are looking at are absolutely no use in helping you make that decision. Last week, in this column, we published a graph which showed how different investment styles have performed from year to year over the last dozen or so years. Some years, funds managed by so-called growth managers will do better than those run by managers with a value perspective. In other years, funds biased towards smaller companies will do better than those which are large-cap oriented.

This has little to do with the skill of the managers, being largely a function of how the markets or sectors in their chosen specialist spheres have done. When markets are as dominated by large-cap stocks as they were from 1995 till 1998, even the best small-cap fund manager will struggle to post good figures relative to the market as a whole, and vice versa.

The only fair way to judge a manager's performance is to assess his (or her) track record against an appropriate benchmark, which is, typically, a market index that matches the style of investment he (or she) is pursuing. Scanning the latest performance figures for unit trusts for the period to June 30 1998 throws up interesting sidelights on the current situation. The last six months have seen the beginnings of what could be a significant turnround of fortunes for sectors previously out of favour. For the first time in ages, smaller company funds have outperformed large-cap stocks.

On the international stage, Japan and many of the Far East emerging markets have rebounded strongly from last year's nadir. The comparison of most recent performance, stacked against longer-term performance, and a view of how these figures would have looked six months ago, is interesting.

The tables with this column set out the average performance figures for different types of equity fund in the 1980s and1990s, and give six- month and three-year figures for the different sectors: (a) As they looked at the end of June this year; and (b) As they looked at the end of December last year. The most striking feature of all the tables is how suddenly and dramatically fortunes can turn.

Japan and smaller company funds have done well in the last six months, despite having by far the worst track records over the previous three years. The questions to ask yourself are: (1)How many of you would have picked either sector on the strength of the figures as they looked at the end of last year?; and (2) How many Japanese unit trusts did you see advertised, highlighting how they had lost you 38 per cent of your money over the three years?

By definition, most of the funds most heavily advertised are the ones with the best track records over fairly long periods.Yet these, as the first two tables also illustrate, are not necessarily much use. If you looked over the 1980s at the end of 1989, you would have seen Japan was the best place to have been, having returned more than 30 per cent a year over the the decade, and North America was at the bottom of the pile.

Yet, since the start of the decade, Japan has been the worst-performing sector by far, and North America (led by the great boom on Wall Street) the best.

What happens from here on? The truth is that nobody knows with precision. If they did, investment would be an easy game. For unit trust investors, it is not worth speculating about the short term, since unit trusts don't make any sense as a short-term investment vehicle, because of their high upfront costs. But on a medium- to longer-term view, Japan still looks a reasonable bet on a risk-return basis, and it is hard not to see smaller companies doing better relative to large-cap stocks from here, though you might have to live through a bear market to see the fruits. Ultimately it is all about balancing risk and reward.

It is little comfort to be told what goes up must come down, and vice versa, but even such skimpy advice is typically of more value than the figures you read in the promotional literature.