Defaqto splits the universe by asset class, and whether the fund is an ETF or an Oeic/unit trust, so we are comparing like with like when rating each fund. Within each of these sub-universes the funds are ranked and scored on the following:
• Ability to track; for example, how well the fund has met its objective – we use ‘r-squared’, which measures the correlation between the returns of the fund and its respective index, over both 1- and 3-year periods.
• Ongoing charges.
• Number of distribution partners (Oeics and unit trusts only) – a key plus for any fund is being available through many platforms.
• Fund size – it is generally accepted that most funds are not particularly profitable or comfortably sustainable until they reach a certain size.
• Group AUM – gives an indication of scale and resources.
• Return on any stock lending for funds that hold physical securities.
• Counterparty risk for funds that engage in synthetic replication.
• Undertakings for collective investments in transferable securities (Ucits) compliance and domicile – a key plus for any fund today is having Ucits status, because it gives investors some assurance that certain regulatory and investor protection requirements have been met.
These are added up to give an overall Diamond Rating, with 5 indicating the best quintile in that market and 1 the worst. When totalling the individual scores, the above factors are weighted such that ability to track accounts for half of the Diamond Rating.
We always keep an eye on market developments and regulatory influences and may sometimes update our rating criteria in order to remain up-to-date.
Combining active and passive
There can of course be both active and passive investments in an investor’s portfolio. Many people believe some markets, such as US equities, are very efficient and already highly researched by fund managers and analysts.
Therefore, index trackers might be best for that part of a portfolio, as it is harder for a manager to add any further value. Emerging Markets, however, are less efficient and researched, offering more scope for active management in that area.
There may be occasions when it makes sense for investors to hold both active and index funds within the same asset classOther studies, though, have shown high proportions of active managers of less ‘efficient’ asset classes have underperformed their benchmark, with there being a greater percentage of underperforming managers than for the more efficient classes.
