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Monitoring – an overlooked aspect of fund selection

However, in this respect ‘unusual’ is equal to lagging performance. “Quantitative factors are our lead indicators. Once a fund starts to underperform towards the 2% mark, that’s an orange flag for us,” she adds.

Tim Peeters, head of securities portfolios at Portolani in Antwerp, also focuses primarily on quantitative screening.

“We conduct quantitative screenings a few times a year for all funds on our list,” he says. “Depending on the sort of fund, we prioritise return, Sharpe ratio, maximum drawdown or market correlation”.

Like Wennonen-Kärnä, Peeters will only scrutinise a fund once it is starting to “lose its shine” in terms of performance. He also requires his managers to help him during the monitoring process.

“We ask managers to regularly write notes to update us about developments within the fund’s management that could affect performance, such as changes in the team. When questions arise about a fund, I’ll have a conference call with the manager within a week.” 

Red flags

Monitoring a fund closely may help to identify ‘orange flags’ early, but you will still have to decide at what point an orange flag turns to red, meaning the fund will be sold.

Vetter urges fund selectors to commit to pre-defined performance targets when buying a fund, in the form of an objective set of criteria. This would prevent investors from holding on to a fund that is not fit for purpose, because of a lack of an alternative, for too long.

Peeters employs ‘deselection criteria’, though he has not laid them out specifically in a document. “Bigger firms should do that, but I think it’s not strictly necessary for a small family office like ours.

“We would need a whole range of documents because the deselection criteria are not the same for every fund. An absolute return fund with volatility above a certain threshold will, for example, be immediately deselected, but this is not the case for an equity fund,” he explains.

Wennonen-Kärnä disagrees with Vetter on the necessity of performance targets. “The funds we invest in have to be a good fit in order to minimise risk. That’s why we do not have exact targets for a single fund. It’s the complete solution that matters,” she says. 

To avoid confirmation bias kicking in, fund monitoring is taken on by 10 portfolio managers, which is a much larger group than the three who took charge of the initial selection process.

Maintaining a list of back-up funds is easier said than done, either because there are few good funds available in certain niche areas, or resources are insufficient to monitor an additional batch of funds. According  to an EI poll, the majority of European fund selectors don’t have back-ups for all their funds, and a fifth don’t have any reserve funds at all (see chart 2 above). In that case, one could park the money in an ETF while searching for a new fund, Vetter suggests.

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