The range of funds available for investors keeps growing each year. So how do you choose a fund that is right for you? 

In this article, we will explore the main types of funds and what to look for when selecting a fund.
 

What is a fund?

Firstly, the basics. A fund is essentially a pool of money that is invested and professionally managed to generate a return for the investors. 

Funds can come in listed form such as Exchange Traded Funds (ETFs) or Listed Investment Companies (LICs). ETFs and LICs can be bought and sold on exchanges in the same manner as shares in companies. 

Unlisted funds, also referred to as managed funds, are a type of unit trust where investors buy and sell units, either directly from the fund manager or via an investment platform.
 

Passive versus active

In simplistic terms, funds can be broken down into two types: active and passive. 

A passive fund generally tracks an index. An index is simply a method of tracking the performance of a group of assets in a standardised way. 

A key example of an index in Australia is the S&P/ASX 200 Index. This index tracks the largest 200 companies on the ASX with the weight of each company in the index determined by their size. 

When this article was written (in October 2022), BHP Group (ASX: BHP) was the largest company on the ASX and made up just under 10% of the ASX200. 

By contrast, an active fund is where the fund manager is generally seeking to beat the index by holding positions different to the index composition based on their own analysis and conviction.

Funds come in many flavours and are generally available across the major asset classes such as equities, bonds, property and infrastructure.

Of course, every investment journey starts with your own goals. To help you as you work through your investment goals, here are a few things to look for when considering active or passive. You’ll notice some similar things to look for across both.
 

Passive investing

• Fees. Passive funds are generally cheaper than active funds. Indeed, passive funds that track the most common indices can be very cheap. This is because the indices are rules based and relatively easy to track for a passive fund manager.
  
  
• Scale.  Size is important when it comes to passive investing. Large funds can keep costs down and give better exposure to the entire index. Funds can either buy every company in the index or use an optimised sampling to replicate the index without buying every company. Ideally you want to invest in a fund that replicates the index as closely as possible.
  
  
• Performance. Ideally the fund’s performance should match that of the index before fees are deducted. Looking at past performance to see if this has been the case is a good way to judge how well the manager is tracking the index.
  
  
• Passive investing can be an efficient and transparent way of getting exposure to the market and can bring the benefits of diversification. Diversification is essentially not putting all your eggs in one basket. Passive funds that track the broader market such as the ASX200 provide exposure to a diverse range of companies across many industry sectors. 
  
  
• Be prepared for some volatility. Passive investing can be volatile, given that you are fully exposed to the market. 
  

Active investing

• Generally speaking, many active managers will fail to add value above an index. This can depend on the type of fund and the asset class. The trick is to try to find the active fund managers that can and do outperform.
  
  
• Fees across active management can vary significantly. A lot of different factors can influence fees, but generally speaking active investing involves more effort than passive investing. Normally this requires more people and effort which comes at a cost. Nevertheless, it is important to compare fees across funds.
  
  
• Performance. It is true that you can’t rely on past performance as a guide to future performance. However, past performance over the longer term can be a useful guide to how the fund might perform in the future. Don’t use it as your sole reason but pay attention to how the fund has performed in the past. Most importantly, look at net-of-fees performance to make sure that you are getting value for money.
  

Other considerations

It is important both to measure and to invest according to the right time horizon (for active and passive funds). Most investing can be for the long term, and you should ensure that any assessment of a fund manager is over the right time horizon. 

It is your money, so you should do your best to ensure that you are investing with a reputable fund manager. 

Things to consider when choosing a fund manager include: 

• How long have they been in business? 
• Are they profitable? 
• What does the ownership structure look like?
• Who are the people that are looking after your money? 
• What kind of skills and qualification do they have? 
• How long have they been doing it?

If this all seems overwhelming, then you can access research from a third party. Firms like Morningstar have experienced researchers who can provide an independent view of both active and passive funds. The ratings of individual funds consider all of the above and more, and can be a useful guide to narrowing your choice.