The biggest dilemma for investors looking to use their ISA allowances is finding a robust and repeatable process for identifying those funds with a greater chance of outperformance. As valuations and the market rally look increasingly stretched it’s even more important to have follow a reliable process.
With Hindsight, I’m A Genius
If we look at the best fund on a total return basis starting when ISAs began in 1999 the best fund was Marlborough Special Situations, growing to £707,655.
That is a huge profit of £541,295 on the amount invested (tax free!)
If you had opted for a fund tracking the index you would have made a less than mediocre £96,747 profit.
As they always say: hindsight is 20:20. But if you are fortunate enough to have picked the right fund the rewards can be huge.
Shockingly Bad Funds
Unfortunately, if you get it wrong things can go very badly. If you had ended up picking the worst performer (on a total return basis from 1999) – a Japanese fund – your fund would be worth £231,960. That’s only £65,600 more than the amount invested.
A HUGE Extra Profit With A Proven Process
So, if you aren’t going to go for the pin-in-the-paper approach, what are the alternatives? You could opt for a tracker but the results look mediocre at best.
How about using a momentum strategy to buy winning funds?
One straightforward example illustrates the point.
The profit would have been £530,922 if you had used our momentum-style Dynamic Fund Ratings to select funds from the popular UK All Companies sector.
This profit is more than 5x that of the index tracker!
Clearly by making much better fund choices you can make extraordinary profits from ordinary funds. Differentials this great illustrate that using a proven process can be genuinely life-changing.
For example, if you wanted the ISA to generate income through a long retirement, you can now generate an income 5 times greater than if you had bought index trackers in your ISA.
This same process which underlies our Dynamic Fund Ratings is proven over periods longer and shorter, and across many fund sectors (evidence here).
How Dynamic Fund Ratings Work
A successful method for choosing funds must have these criteria:
- Straightforward to identify top rated funds
- Underlying process must be clear and understandable
- Process must be repeatable
- Long term evidence of extra growth being achieved
We back tested various methods for selecting funds back to 1994. The method which stood head and shoulders above alternatives was what we now call Dynamic Fund Ratings.
The Dynamic Fund Ratings met all of our criteria for an effective rating system:
- The funds to buy are given 5 stars. Couldn’t be simpler
- The 5 star funds are the top 20% of funds over the prior 6 months
- It is easy to repeat this process every 6 months
- The evidence for achieving extra performance is superb
It works like this, assuming you apply it to the popular UK All Company sector which we used in the example above:
- Buy the top-rated fund using Dynamic Fund Ratings.
- Sell this 6 months later,
- and then buy the top-rated funds of the most recent 6 months.
- Repeat this every 6 months
Straightforward. Proven. Efficient.
The Lesson For Investors?
Investor inertia, complacency, ignorance, gullibility - call it what you will - is very expensive. The best investors in the world ALL have a clear process.
Despite the unfavourable market conditions the outperformance of momentum investing, using funds, was huge. But you must make sure you are in the right funds.
That’s what momentum investing does - it ensures you are always in a fund with a high likelihood of outperforming. And it’s not about market timing or luck with momentum investing, though it is with buy and hold.
Don’t fall victim to investor inertia. Those who “invest and forget” could end up much worse off than the mediocre performance of an index tracker.
ACTION FOR INVESTORS
Choose a method for selecting funds:
- Pin: not a realistic option
- Tracker: a less than mediocre outcome
- Process: something you can easily do and with a mountain of evidence proving its success (at least in the case of Dynamic Fund Ratings)
FURTHER READING
Table 1: Top ISA fund, Dynamic Fund Ratings portfolio and index tracker returns
|
Fund
|
Value today (£)
|
Profit in excess of total ISA contributions (£)
|
|
Marlborough - Special Situations
|
707,655
|
541,295
|
|
HSBC - FTSE 100 Index
|
263,107
|
96,747
|
|
Dynamic Fund Portfolio - UK All Companies sector
|
697,282
|
530,922
|