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Red flags for fund research

11 Sep, 2023 | Return|

Conducting thorough research on funds within a portfolio is a crucial part of the due diligence process to ensure that a client’s money is well-managed and protected. During the fund selection process, there are a number of red flags to consider that may indicate potential risks or issues. In this short article, Square Mile’s Research Director, John Monaghan, highlights some of the red flags the team consider when meeting with fund managers.

1. Staff and operational issues

One area of concern is personnel-related issues or operational challenges that could impact the viability of an investment firm. For instance, a high turnover rate amongst an investment team, including the lead fund manager or their supporting team, is likely to raise eyebrows and prompt further investigation. Furthermore, any corporate activities that cast doubt on the long-term health of a firm should be examined, along with issues surrounding non-investment resources such as compliance, risk management, and marketing.

2. Sudden changes in investment philosophy

From an investment perspective, significant deviation from an established process and philosophy can signal cause for concern. This red flag warrants scrutiny to understand the reasons behind the shifts in investment objectives or styles. It could well be that the rationale is justified, perhaps due to the wider economic backdrop, but further investigation will minimise the risk for an unexpected surprise for investors in the future.

3. Deviation from expected outcomes

Though specific to Square Mile’s process, there is an additional consideration which signals a red flag: a fund's expected outcome. The expected outcome represents Square Mile's assessment of the likely investor journey based on the fund manager’s process. By comparing a fund's actual performance against this expected outcome, any significant deviations can trigger further investigation and, therefore, it is essential to verify whether the deviation is justified or reasonable.

Square Mile employs a combination of data analysis and strong relationships with management groups to help identify any red flags throughout the research process. By reviewing each sector on a quarterly basis and examining factors such as fund performance over various time frames, inflows or outflows, and team changes, it is possible to stay on top of key indicators that may affect a fund's rating. Such an approach ensures that a fund has the ability to perform as expected in the future.

Importantly, it is crucial to adopt a case-by-case approach for each area of concern. By examining each situation individually, it becomes possible to assess specific reasons for any company or team issues, as well as performance deviations. Doing so means a full and thorough picture is built. In some instances, that fuller picture demonstrates that the red flag may not be a drag on achieving a fund’s objective. In others, it may necessitate taking action and changing a fund’s rating.

Fund research, due diligence, and ongoing monitoring are fundamental in protecting your client’s interests. By remaining alert to some of these red flags, you can continue to ensure that the recommended funds align with your client’s goals and risk tolerances. At Square Mile, our qualitative research aims to support you in making the most informed investment decisions, with detailed insight and opinion on over 350 funds, which we believe have the best prospects of meeting their expected outcomes.

Visit our free-to-access Academy of Funds to read the latest research on all our rated funds.


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