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How do portfolio management
teams of actively managed
funds select new investments? They:
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Analyze economic trends.
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Perform industry analysis.
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Meet with company
management.
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Study the competitive
environment.
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Review income statements
and balance sheets.
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Utilize proprietary valuation
techniques.
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If you opt to invest in mutual funds, your next question
may be whether to choose index funds or those that
are actively managed. Index funds try to mirror market
indices – not beat them. These funds buy and hold all, or a
large representative sample, of the securities in their target
indices. With index funds, there is no management team
evaluating the merit of each individual security within the
fund's holdings. Instead, the team is there to maintain the
benchmark. Additionally, an index fund manager cannot choose to invest
more heavily in a company they believe will outperform
the benchmark.
The manager of an actively managed fund seeks to
produce investment returns that are better than the fund's
designated market benchmark by buying and selling
individual securities that they believe will outperform the
market. Each manager follows a stated strategy for trying
to beat the market by following macroeconomic trends,
visiting companies, reviewing balance sheets and income
statements, and closely following the day-to-day workings
of a company.
While active management typically results in higher
costs, extra value may often be derived from this approach
because it allows fund managers to buy and sell securities
based on their extensive research, as well as company
and industry knowledge.
Find the investment philosophy to suit you.
Fund managers focus on different strategies and unique
investment philosophies. Some follow a bottom-up
approach, searching first for outstanding performance of
individual securities before considering the impact of broad
economic trends. Others practice a top-down approach,
looking at trends in the general economy and select
industries before choosing companies that should benefit
from those trends.
No matter which investment philosophy you select, it makes
more sense to choose managers who have demonstrated
their talent and discipline over time and seek to deliver longterm
performance. Find a fund manager who has a number
of years' experience in a specific category. Choose someone
with a proven track record and a demonstrated ability to dig
deep to find companies that may be poised to outperform
their peers. You'll often find this type of background
information in a fund's annual report and prospectus.
 Next: What you should know about mutual fund expenses
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