Exploring Mutual Funds – Choosing the right Equity Funds for your Portfolio

Ray Calleja

An article written by Ray Calleja: Head – Private Clients, MeDirect

So far in our weekly articles we have looked at how a mutual fund has performed, how risky has it been, what is in the portfolio, who is managing it and how much does it cost. These are the factors that you need to consider whether you are choosing your first or your umpteenth fund.

However, if you are setting out to build up your investment portfolio of funds, there are some basic rules that you are recommended to follow. If you are considering your first equity fund you must see that it is well diversified. That means that the fund should hold a large number of stocks from a wide range of industries and sectors. The factsheets available for each fund available on the MeDirect website will tell you how many equities a fund owns as well as which sectors, they come from.

Most of the time funds which own many equities from many different sectors are generally more stable than those only holding shares in a few companies from a limited number of industry sectors.

This approach is also endorsed by our partners Morningstar, who advocate that you should own a core equity fund or two which form the foundation of your investment portfolio. They also state that investors are more successful when they buy a fund and hang on to it for many years. If you like and understand a fund’s approach then you are more likely to feel comfortable hanging on that fund, even during challenging and volatile times. A rule of thumb is that at least three-quarters of your equity holdings should be in so-called core funds. By core funds, we mean funds that are broadly diversified across sectors and individual equities. They are funds which do not put the bulk of their assets in small-companies but rather focus on large-company stocks. A simple guideline is to use the Morningstar style box, where you can look for large-growth, large-value or large blend funds. Large-value funds own equities which are undervalued; large-growth own shares in companies which have strong growth prospects and large-blend own companies with a combination of these two characteristics.

Knowing the difference between growth and value styles is important in building the investment strategy that is right for you. Combining different types of investments can also help to build a diversified portfolio.

Growth Equity funds invest in growth equities. These are equities in companies that are expected to grow at a faster rate when compared to the overall equity market. They are usually considered aggressive investments because they tend to have a relatively higher risk, along with relatively higher performance, compared to the main market indices.

Technology stocks, such as Netflix, Microsoft, Amazon and Facebook are good examples of what growth equity mutual fund managers buy for their funds. Growth funds pay little or no dividends so the return to the investor lies in the hope that there will be price appreciation of the underlying investment; whereas the return to the investor for value/income funds can be a combination of price appreciation and yield (dividends). An obvious indicator of a growth fund is often found with the word “growth” in their names.

In contrast Value Equity funds primarily invest in value equities, which are equities that an investor believes are selling at a discounted price in relation to earnings or other fundamental value measures. Value managers apply fundamental analysis by researching and analysing companies’ financial information to determine if the stock is under-valued and if it represents a ‘good value’ if purchased. As with the case of growth funds, value funds often include the word ‘value’ in their name. Equity funds that pay dividends are often considered value funds. This is why value funds are often referred to as ‘income funds.’ Investors may opt to take out the income or yield provided from such funds by choosing the income variant of the fund or they may also choose to invest in the accumulator versions whereby the managers add any income they receive from the underlying investments added to the existing fund. Therefore, value stock funds can also be purchased for the purpose of long-term growth, although the name or objective is not literally ‘growth’.

Growth and value are different styles of investing in equities. The growth style tends to have a higher degree of market risk with greater potential for higher returns compared to value investing. For a diversified portfolio, investors may consider a combination of growth and value. This is where blended funds come in, which are mutual funds that include a mix of both value and growth stocks and thus offer diversification among these popular styles in a single portfolio.

If you already own more than one equity fund do make sure that the funds do not significantly overlap one another. Many investors who select good funds may be unaware that they may be holding two or three funds which are essentially very similar funds. If the overlap among the holdings in companies that they own is very high, then there is no real diversification.

Looking at style drift is also important. If your intention is to be invested in US large caps your fund could actually be invested in, say, mid cap. You also need to look at how many equities they hold. There are large-cap funds that hold only 20 equities. There is more risk in that fund than one that holds 100 equities. Some funds may devote a large percentage of their assets to just one company, which also increases the risk and could therefore make returns unsustainable.  

We next come to the million-dollar question. Are actively managed funds better or worse investments than the passively-managed index funds? Actively managed mutual funds employ portfolio managers who try to outsmart the market by over- and underweighting certain stocks or sectors.

Index Funds

Let us take a look at what Index Funds are. Here, the fund manager is buying the same stocks in exactly the same proportion as a given market benchmark. The objective of the fund is to follow the index and for this reason they are considered as passive investors.

Index funds do have many benefits. Most importantly, they tend to be low in cost, mainly because the fund managers are not actively managing their funds because they are replicating what the index does. Performance of index funds is fairly predictable as they usually provide the same return as their index less the management fee. If, for example, the fund index is the S&P 500 the fund will own large-blend equities and so it will always own the same type of equities because it is what the fund is tracking. This is in sharp contrast to managed mutual funds, where the manager analyses equities and tries to pick the best performing ones. As a result, the portfolio composition of equities in the fund can and will change from time to time.

With index funds, shareholders do not have to worry about the fund manager leaving the fund. If that fund manager does leave, the new one that comes in will still have to follow the same index as before.

Some of the most well-known indices include the S&P 500, the Dow Jones Industrial Average and the Nasdaq 100. Index funds are a popular strategy for ETFs to use. An ETF is a basket of securities that in most cases track an index. The funds that hold the securities are themselves listed like stocks. This means you can trade ETFs like stocks, buying and selling them on a stock exchange. Because an ETF tracks an index, the ETF performance will be very close to that of the index it tracks. ETFs are passive investment vehicles, and in complete contrast to active mutual funds, which aim to outperform a benchmark index. Exchange traded funds allow investors to earn the index return with lower costs than other investment products, which is their main attraction to them by investors. They are in fact cheaper than mutual funds.

Fund of Funds

Another category of funds is the Fund of Funds (FOFs), which are mutual funds that invest in other mutual funds rather than individual equities, bonds and other securities. Just as a regular mutual fund offers the skills of a professional manager, who assembles a portfolio of stocks or other securities, the manager of a FOF will select a portfolio of funds, managed by other managers. The goal of the FOFs is to achieve broad diversification and asset allocation with a variety of funds that are combined into one fund. FOFs often attract smaller investors who want a broader investment exposure while achieving less risk than by investing directly in each individual security.

A FOF allows you access to more funds than you might be able to afford on your own. However, it is worth noting that the FOF structure creates a double layer of costs. First, there are the expenses associated with running the FOF itself—management fees, administrative costs, etc. Second, there are the costs associated with the underlying funds—the same sorts of management fees, administrative costs, and so on. However, there are some FOFs, which eliminate the double-fee problem because they offer FOFs that invest only in their own funds. The fund house then waives the cost of the FOFs and you only pay the costs of the underlying funds.

Going back to the debate between active vs passive investing, the argument goes on unresolved. The choice between index funds and actively managed funds does not have to be either or. You can create a successful portfolio using either strategy or by combining the best of both worlds.

A joint study, earlier in the year, by Morningstar and Hartford Funds gave an insight on active vs passive investing. The white paper* examined the Morningstar Large Blend category because it is widely believed to be the most efficient category—the one that should invariably favour passive investing. Yet even this category showed the cyclical nature of active and passive performance. The same cyclicality is present in other investment categories such as mid-caps, small-caps, and global/international equities outside the US. A look at the last 35 years shows that active and passive investing are cyclical, trading places in terms of their outperformance over large periods of time.

When markets become volatile, the agility and flexibility of active management can become a competitive advantage. During the recent bull markets it was a good time to be in a low-cost, passive investment but when there is the kind of volatility like the one we have seen during the COVID-19 crisis, being in an actively managed fund will carry an advantage because the fund manager can choose to hold cash and not invest until the ‘right’ opportunity comes along. That is a flexibility that gives the active fund the advantage to wait until the market goes lower to reinvest.

As with any investment plan, it pays to consider the strengths and weaknesses of any given strategy. When considering an active manager, be sure to check the fund’s active share (which is a measure of the percentage of equity holdings in a manager’s portfolio that differs from the benchmark index), which will tell you whether it’s mostly mimicking an index or is truly positioned to add value over its benchmark.

The conclusions from the above-mentioned report provided more food for thought for us, the investors, namely that: the performance of active and passive management is cyclical—each style goes through extended periods of outperformance. When evaluating active and passive management, looking beyond recent performance and measuring active share is also important.  As happened in December 2018, market corrections are inevitable and a common occurrence in equity markets over time.  There have been 26 market corrections over the past 31 years, and active management outperformed passive management in 19 out of 26 corrections.  During market corrections, the flexibility of active management allows for reducing exposure on the downside and ramping up exposure to capture alpha in the early stages of recovery.

* Whitepaper – The Cyclical Nature of Active & Passive Investing by HartfordFunds 02/2020


The above is for informative purposes only and should not be construed as an offer to sell or solicitation of an offer to subscribe for or purchase any investment. The information provided is subject to change without notice and does not constitute investment advice. MeDirect Bank (Malta) plc has based this document on information obtained from sources it believes to be reliable but which have not been independently verified and therefore does not provide any guarantees, representations or warranties.

MeDirect Bank (Malta) plc, company registration number C34125, is licensed by the Malta Financial Services Authority under the Banking Act (Cap. 371) and the Investment Services Act (Cap. 370).

The financial instruments discussed may not be suitable for all investors and investors must make their own informed decisions and seek their own advice regarding the appropriateness of investing in financial instruments or implementing strategies discussed herein.

If you invest in any of the products discussed you may lose some or all of the money you invest. The value of your investment may go down as well as up. A commission or sales fee may be charged at the time of the initial purchase for an investment and may be deducted from the invested amount therefore lowering the size of your investment. Any income you get from this investment may go down as well as up. This product may be affected by changes in currency exchange rate movements thereby affecting your investment return therefrom. The performance figures quoted refer to the past and past performance is not a guarantee of future performance or a reliable guide to future performance. Any decision to invest in a mutual fund should always be based upon the details contained in the Prospectus and Key Investor Information Document (KIID), which may be obtained from MeDirect Bank (Malta) plc.

BlackRock Commentary: Downgrading U.S. equities to neutral

Mike Pyle, Global Chief Investment Strategist, Elsa Bartsch, Head of Macro Research, and Kurt Reiman, Senior Investment Strategist for North America, all part of the BlackRock Investment Institute, share their insights on global economy, markets and geopolitics. Their views are theirs alone and are not intended to be construed as investment advice.

We have downgraded U.S. equities to neutral on a tactical basis, after a strong run of outperformance versus global equities since the March trough. We see a surge in COVID-19 cases in the U.S. potentially slowing the activity restart at a time when fiscal stimulus is at risk of waning. Yet the quality bias of the U.S. market lends some support and keeps us from turning negative.

07.07.2020 BlackRock Article Image 1

Past performance is not a reliable indicator of current or future results. It is not possible to invest directly in an index. Sources: BlackRock Investment Institute with data from Refinitiv, as of July 1, 2020. Notes: The lines show the performance of U.S., developed markets outside the U.S. and emerging markets, rebased to 100 on Jan. , 2020. The indexes used are the MSCI USA, MSCI World ex-U.S. and MSCI emerging Markets indexes.

U.S. stocks have outperformed in 2020, with a sharper recovery from the troughs of late March. See the chart above. This follows a multi-year stretch of outperformance of U.S. equities, driven by strong earnings growth as well as investor preference for tech and quality stocks. We now see a risk of more muted performance in line with global equities on a tactical horizon. New COVID-19 cases in the U.S. have been surging, prompting some states to roll back or pause their re-openings. This is potentially setting the U.S. on a very different activity restart path than most Western countries and much of Asia. Whether or not governments reimpose lockdowns, individuals may respond by reducing their mobility – as we observed at the onset of the pandemic. We view mobility as a key indicator of activity as economies restart, as detailed in our Midyear Outlook. As a result, failure to contain the virus may threaten America’s activity restart.

The outperformance of U.S. stocks in recent months has largely been supported by the historic policy response. The U.S. has so far delivered coordinated fiscal and monetary support sufficient to offset the estimated initial shock from the pandemic and spillovers to the full economy. Yet the resurgence of the virus is taking place just as Congress and the White House face a critical decision over whether to extend a number of crisis measures, including additional federal unemployment benefits set to expire at the end of July. Any premature reduction of stimulus in July, and as the shock persists, would increase the risk of financial vulnerabilities among businesses and households facing cashflow stresses. The risk of retrenching fiscal policy too soon in the U.S. comes as the euro area has been galvanizing its policy response to the coronavirus shock.

A slower economic restart could further dampen the earnings prospects of U.S. companies. Earnings per share of the benchmark S&P 500 Index are expected to decline 44% in the second quarter from a year earlier. That follows a 12.7% fall in the first quarter. Consensus estimates suggest U.S. corporate earnings will return to their 2019 levels by 2021, but we see downside risks given the likely slower restart. Renewed U.S.-China tensions and a looming presidential election with a historically wide gap between parties on policy add to the uncertainty.

What’s stopping us from turning negative on U.S. equities then? The U.S. market has a high concentration of quality companies – especially in technology and communication services – that are set to benefit from structural trends accelerated by the pandemic. We have upgraded the quality style factor in our Midyear outlook to a strong overweight, preferring it as the most resilient exposure against a range of potential outcomes. And U.S. equity valuations do not look substantially out of line to us, with the equity risk premium above its long-term average.

Bottom line: The resurgence of COVID-19 cases in the U.S. threatens the restart of activity, and has prompted us to downgrade U.S. equities to neutral over our six-to-12 month tactical horizon. Yet the relative quality bias of this market keeps us neutral overall. We prefer European equities, which we have upgraded to a tactical overweight. The region offers more attractive cyclical exposure than emerging markets due to its public health measures and ramped-up policy response, in our view.


Market Updates

07.07.2020 BlackRock Article Image 2

Past performance is not a reliable indicator of current or future results. It is not possible to  invest directly in an index. Sources: BlackRock Investment Institute, with data from Refinitiv Datastream, July 2020. Notes: The two ends of the bars show the lowest and highest returns versus the end of 2019, and the dots represent year-to-date returns. Emerging market (EM), high yield and global corporate investment grade (IG) returns are denominated in U.S. dollars, and the rest in local currencies. Indexes or prices used are: spot Brent crude, MSCI USA Index, the ICE U.S. Dollar Index (DXY), MSCI Europe Index, Bank of America Merrill Lynch Global Broad Corporate Index, Bank of America Merrill Lynch Global High Yield Index, Datastream 10-year benchmark government bond (U.S. , German and Italy), MSCI Emerging Markets Index, spot gold and J.P. Morgan EMBI index.


Market backdrop

Measures to contain the virus have been gradually being eased in many developed economies, lifting activity and employment in June. A surge of COVID-19 cases in the U.S. threatens to slow the restart. We are tracking the interplay of containment measures and mobility changes on activity as economies have started to reopen. The unprecedented policy response has boosted markets, leaving a potential resurgence of infections and policy implementation as key risks. U.S. Congress is headed for a fiscal cliff as jobless benefits, state support and payroll protection measures are expiring soon.

Week Ahead

  • July 6th:  U.S. ISM non-manufacturing purchasing managers’ index (PMI), services PMI; euro area retail sales
  • July 9th: China inflation data
  • July 10th to 17th: China money supply and total social financing

Markets will focus on the U.S. non-manufacturing and services PMI data this week. The reopening of the economy set the stage for a rebound in manufacturing activity in the U.S. in June, and likely has also helped improve services sector activity. Yet a pickup in virus infections in June, particularly in the U.S., could weigh on July’s high-frequency activity data. Markets are closely watching how well governments contain such outbreaks to avoid permanent scarring of the economy. 

BlackRock’s Key risks & Disclaimers:

This material is not intended to be relied upon as a forecast, research or investment advice, and is not a recommendation, offer or solicitation to buy or sell any securities or to adopt any investment strategy. The opinions expressed are as of July 6th, 2020 and may change. The information and opinions are derived from proprietary and non-proprietary sources deemed by BlackRock to be reliable, are not necessarily all-inclusive and are not guaranteed as to accuracy. As such, no warranty of accuracy or reliability is given and no responsibility arising in any other way for errors and omissions (including responsibility to any person by reason of negligence) is accepted by BlackRock, its officers, employees or agents. This material may contain ’forward looking’ information that is not purely historical in nature. Such information may include, among other things, projections and forecasts. There is no guarantee that any forecasts made will come to pass. Reliance upon information in this material is at the sole discretion of the reader.

The information provided here is neither tax nor legal advice. Investors should speak to their tax professional for specific information regarding their tax situation. Investment involves risk including possible loss of principal. International investing involves risks, including risks related to foreign currency, limited liquidity, less government regulation, and the possibility of substantial volatility due to adverse political, economic or other developments. These risks are often heightened for investments in emerging/developing markets or smaller capital markets. 

Issued by BlackRock Investment Management (UK) Limited, authorized and regulated by the Financial Conduct Authority. Registered office: 12 Throgmorton Avenue, London, EC2N 2DL.

MeDirect Disclaimers:

This information has been accurately reproduced, as received from  BlackRock Investment Management (UK) Limited. No information has been omitted which would render the reproduced information inaccurate or misleading. This information is being distributed by MeDirect Bank (Malta) plc to its customers. The information contained in this document is for general information purposes only and is not intended to provide legal or other professional advice nor does it commit MeDirect Bank (Malta) plc to any obligation whatsoever. The information available in this document is not intended to be a suggestion, recommendation or solicitation to buy, hold or sell, any securities and is not guaranteed as to accuracy or completeness.

The financial instruments discussed in the document may not be suitable for all investors and investors must make their own informed decisions and seek their own advice regarding the appropriateness of investing in financial instruments or implementing strategies discussed herein.

If you invest in this product you may lose some or all of the money you invest. The value of your investment may go down as well as up. A commission or sales fee may be charged at the time of the initial purchase for an investment and may be deducted from the invested amount therefore lowering the size of your investment. Any income you get from this investment may go down as well as up. This product may be affected by changes in currency exchange rate movements thereby affecting your investment return therefrom. The performance figures quoted refer to the past and past performance is not a guarantee of future performance or a reliable guide to future performance. Any decision to invest in a mutual fund should always be based upon the details contained in the Prospectus and Key Investor Information Document (KIID), which may be obtained from MeDirect Bank (Malta) plc.


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