The mutual fund companies have provided investors with a large basket of funds to pick from.  However they have only complicated the task an individual investor faces in building an investment portfolio.  The number of funds has been growing every year since the first mutual fund was started in 1924 by Massachusetts Investors Trust.  From that simple start the industry experienced slow growth up through the 1940’s and into the 1960’s.  By then there were still only 160 funds holding a combined $17 billion in assets.

By 2003 the total number of funds available has reached the 8,000 mark and
the total dollars invested in mutual funds totals nearly $7.41 trillion.  Today approximately 75% of the funds are held by individual investors and the remaining balance is held by institutional investors and fiduciaries such as trusts, guardians and administrators.

With the increasing number of funds the variety among the funds has expanded  as well.  Besides the more traditional choices of large cap funds, bond funds and international funds, investors can now pick sector funds that only invest in certain market areas such as gold, real estate, retail services,
banking, entertainment and so on.  To say the choice is robust would be an
understatement, however at the same time all of those choices can cause
investors to be a little overwhelmed.

To help cut through the hesitation and confusion that may arrive when
selecting among the many different funds, here are a few of the criteria we
use when selecting funds for a clients portfolio.

What an investment counselor does.

Before making the individual fund selections it is imperative that you fully
understand the investor’s risk tolerance level.  You have to be clear in
your mind how much variation or volatility the investor is willing to
endure.  For older investors with less time to average out the inevitable
fluctuations in the markets you probably need to keep the volatility down to
where the standard deviation of the portfolio is no more than 30% of the
average return in the portfolio.  Younger investors with more time to invest
usually opt for higher average returns and the accompanying wider range of
returns.

After determining the acceptable level of risk, you need to make sure you
have properly diversified the portfolio.  This goes hand in hand with the
risk tolerance measure because by combining numerous asset classes and
investment styles, you can dramatically decrease the overall volatility of
the portfolio.

Just as an accomplished chef can make a tasty meal out of a variety of
ingredients and flavors, you can build a very palatable portfolio by mixing
asset classes and styles.  In a typical portfolio we will combine three
different asset classes, equity, debt and hard assets, and 5-7 investment
styles to properly diversify the portfolio.  With portfolios in excess of
$500k, we will even introduce different managers within each style to
further diversify the portfolio.

In selecting individual funds we first start with the tenure of the manager
and his/her track record during his/her investing time frame.  I prefer to
use managers who have a few wrinkles on their brow and a few gray hairs in
their head.  Years ago I would give a young hotshot manager running a fund
an opportunity to manage client’s money.  Seldom did that experiment pay
off.  They may have had a hot streak that ran for a year or 18 months, but
seldom did they have the experience or maturity to consistently deliver
above average returns.  I like to see a manager who has been at the game in
a responsible position for at least 10 years.

The next criterion I look at is their performance relative to their peers
and to the appropriate benchmark.  Typically I prefer to see their
performance in the top half of the percentile rankings of both measures in
at least 5 of the last 7 years.  Everyone has an off year once in a while, but when I see three years in a row or 4 of the last seven where they failed
to beat the average returns of their peers it is time for a change.

I also prefer managers who are consistent in their investment philosophy.  I
don’t like to see a manager using a growth philosophy one year and a value
approach the next.  If they are not going to stay in their style box, it
just makes my life as an investment manager all the more difficult.  I don’t
like surprises when it comes to managing people’s money and when the
managers I hire on their behalf don’t adhere to one investment discipline, I
find someone who will.

I also look at fund expenses.  I look for expense ratios that are below the
industry average for that particular style.  You can’t really compare the
funds expenses of a large cap value manager versus a small cap growth fund.
They operate in very different manner and a successful small cap manager
with an outstanding track record is afforded more latitude when it comes to
investment expenses.  I still prefer they remain below the industry average,
but by no means are they compared to a buy and hold strategy their large cap counterpart may have.

Contact Mark Neil at:
Northwest Wealth Advisors, Inc 
0605 SW Taylors Ferry Road
Portland, OR 97219
Office: (503) 478-6632 
Fax: (503) 595-1863 
Email: mneil@nwwealtadvisors.com 
Website: http://www.nwwealthadvisors.com/

© 2004 Mark Neil