Martin Hawes: Allocation, allocation

Managed funds are continually in the news - and with more than a million people in KiwiSaver, this will be the case for the foreseeable future.

This is a good thing - I always thought that one of the positive effects of KiwiSaver was likely to be that with so many people invested in managed funds we would think (and talk) about them more.

Increasingly, my mail box has had more questions about what is a good fund and what is not - and, of course, which funds investors should be in and which they should leave alone.

Many factors should determine the fund you invest in: cost, reputation and skill of the manager, etc, but the one thing that stands head and shoulders above all others is the type of things the fund invests in.

This is called asset allocation and is by far the biggest determinant of the fund's performance.

Occasionally, a manager may have an eccentric investment strategy - for example, Huljich invests 13 per cent of its fund in a small company called New Image - but assuming the manager stays fairly well in the mainstream, returns will be mostly determined by asset allocation.

Asset allocation is the proportion that goes into the main asset classes of shares, property and bonds/deposits. It is the way these are apportioned that you as an investor need to think about.

A fund which is 50 per cent bonds and 50 per cent shares is likely to give completely different performance (risk and return) than one which has, say, 80 per cent in bonds and 20 per cent in shares (again, assuming that the manager has not done something seriously strange).

Each of the asset classes has different risk/returns characteristics and the way you mix and match them will make the difference.

You should think of the asset classes as the big building blocks of the portfolio you are constructing - specific investments or timing are mostly just fine tuning.

So, someone investing for a long period (say, a 30-year-old investing for retirement in 35 years) would look first for a fund which has a high proportion in shares and property and only then consider other factors.

However, a 22-year-old who plans to access her KiwiSaver account to buy her first house in five years does not want volatility so should look at funds which invest in cash and bonds.

It is the asset allocation of the fund that makes the greatest difference and it is this that you should worry about more than anything else.

No matter how brilliant, a fund manager invested mostly in shares will experience a lot of volatility - and even the best fund manager who is only in bonds cannot get better long-term returns than an average share fund.

* Martin Hawes is a financial adviser. His disclosure statement can be found at www.martinhawes.com