Why an Investment Process is Critical

Pick your funds and your strategy carefully.

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Roger Wohlner

In the investment world the disclaimer “past performance is no guarantee of future performance” is often used, with good reason. If we apply this to the world of mutual funds any number of factors can come into play. I and many other advisers have migrated in large part to passive, low-cost index funds and ETFs simply because so few active managers deliver top returns year in and year out.

A repeatable process is the key element in investment success. There will always be fluctuations in the performance of various investments whether they are individual stocks or bonds or managed products such as mutual funds and exchange-traded funds. Certain asset classes will underperform at various times (such as foreign stocks in 2011). The point is to have an investment process in place that uses a disciplined methodology to make investment decisions. In my experience, this is a key element in long-term investment success.

While some investors may disagree, we believe in careful asset allocation and portfolio rebalancing. We use both active and passive mutual funds and ETFs to fill the allocation slots in client portfolios, and we monitor those holdings on a regular basis.

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Finding mutual funds and ETFs that fit the needs of our clients takes work and ongoing monitoring, but I have found this to be worth the time spent. Even with the best managers there are no guarantees about the future, but analyzing and understanding the details of their past performance can provide insight.

Here are some of the factors that we usually look at when evaluating mutual funds and ETFs (via Fi360):

  • Does the fund have at least a three year track record?
  • Does the fund manager have at least a two year track record with the fund?
  • Does the fund have at least $75 million in assets?
  • Do the fund’s composition (its holdings) and its Morningstar style look like other funds in its investment category?
  • The fund’s expense ratio should be in the category’s 75th percentile. (In reality we like to see this number much lower than that).
  • The fund’s risk-adjusted returns (Sharpe and alpha) in the top 50 percent of its peer group of funds.
  • Trailing 1-, 3-, and 5-year returns at least in the top half of its peer group of funds.
  • Has the fund experienced a significant gain or loss in assets?
  • Has ownership of the fund changed?
  • Has there been turnover in the fund’s management?
  • While a fund’s adherence to these and other factors does not guarantee success year in and year out, it has been my experience that investment managers who score well based on these criteria tend to outperform over longer periods of time.

    The importance of an investment process and a “deep bench” in terms of personnel really comes into play when a mutual fund manager leaves a fund. A change in leadership is a huge red flag, but we don’t always move client assets. Rather we look at whether there is a repeatable investment process in place and if the new manager will follow that process that has proven to be successful for the fund.

    Roger Wohlner, CFP®, is a fee-only financial adviser at Asset Strategy Consultants based in Arlington Heights, Ill., where he provides financial planning and investment advice to individual clients, 401(k) plan sponsors and participants, foundations, and endowments. Roger is active on both Twitter (@rwohlner) and LinkedIn. Check out Roger's popular blog The Chicago Financial Planner where he writes about issues concerning financial planning, investments, and retirement plans.