Search for a decent return

POOR performance is the prime reason why investors switch PEP and ISA holdings but what is a fair way to judge whether or not your investment returns are up to scratch? The whole point of investing is to make a decent return on your money. So when that decent return isn't forthcoming, it can be extremely tempting to switch your cash elsewhere.

Poor investment performance is the number one reason why investors move their money around and approximately 88 per cent of independent financial advisers cite it as the reason for advising their clients to switch.

But judging whether, say, a PEP or ISA fund has delivered poorer returns than you might have reasonably expected is an extremely tricky business.

Past returns have to be put in context of the market and measured against comparable investments before you can judge whether they have been poor or not. So here are some pointers to help you judge if your PEP or ISA funds returns have been below par.

Look first how a fund has performed against funds with a similar investment remit. The best way to do this is to look at its ranking within its investment sector. Sector based returns for unit trusts/OEICs and investment trust can be seen each month in specialist magazines like What Investment and Personal Finance.

Most sector performance tables in newspaper show how funds have performed on a cumulative year basis, say its total return over a three or five-year period. Such figures show just a snapshot in time, based on a particular buy and sell date and give little indication as to a fund's consistency.

To get a wider picture of a fund's performance record, look at cumulative returns over both short and long term periods. What Investment magazine shows fund performance over periods of six months to ten years so in each case, the buy date will be different.

Also try to look performance for as many individual 12 month periods as you can. Such 'discreet' year performance will uncover any distortions in cumulative performance returns brought about by a last minute rise or drop in the unit price.

Once you have sector rankings over different time periods in front of you, it can be hard to draw any clear conclusions as to a fund's performance record. Chances are the fund will have hopped up and down the sector rankings and the fact that the number of funds within a sector changes over different time periods doesn't help.

To make comparisons fair, look how a fund would rank on a quartile basis. That is where it would rank if you simply divided the sector into four quarters the top quartile, second quartile, third quartile and bottom quartile. This will overcome the problem of varying numbers of funds within a sector.

Ideally, a fund should fall into the first and second quartile most of the time, indicating that it has delivered an above average performance for its sector. If a fund veers widely from the first to the fourth quartile on a regular basis, you should find out why.

It may be that it is taking large bets on very narrow areas of the stock market. This type of fund may give you the opportunity to make returns far above the sector average now and then but you may have to accept periods of under performance in return.

As well as making sector comparisons see how the fund has performed against a relevant stock market index.

If, after making detailed comparisons against similar funds and indicators, you come to the conclusion that one of your PEP or ISA funds has under performed, your next step is to look for reasons for the poor returns, as these reasons will help you decide whether it is worth hanging on in the hope of an improvement or whether it really is time to switch to another investment fund.

Identifying poor performance is an important skill but you also need to take measures to mitigate against future poor returns. A common trap investors fall into is to switch out of a poor performance fund into one that has shown good returns only to see the new fund also go into decline.

There is no way to guarantee which funds are likely to provide you with good performance in the future. But there are a few steps you can take to reduce the likelihood of choosing a fund which is about to enter a period of under performance.

Look at market cycles. The time to get into a particular market is when it is still falling, not when it has been rising for months on end.

If you want to get into a very specific area of the market, eg Continental Europe, financial funds or technology, discuss with your financial adviser whether now is a cheap time to buy. Look for consistency. Unless you specifically want a roller coaster ride, try to identify funds which have consistently shown good returns relative to their sector, even if they have never ranked right at the top of the table.

Steady, good returns are the best indication that the manager has found an investment strategy that works under different market conditions. While that may not guarantee how it will perform in the future, it does indicate that the manager is doing something right.

Trevor Kirkley is principal of Redworth Caledonian Associates

Published: 30/01/02