Investing in New Fund Issues

bugbyte_2

I'm 1/2 way through reading Monkey with a Pin and to be honest it is becoming very apparent that using logic and reason to fund pick is a complete waste of time, and statistically I may as well fire arrows at the financial pages. With this in mind, could an alternative fund picking strategy work? So how about this?

Small and Mid Cap companies because of their size are likely to be disproportionally affected by large investments in their shares, so any fund buying into them is likely to create a bull run, with other investors joining in. Therefore, when a new mid / small cap fund is launched, the fund is bound to go up in the first few weeks as the new investment is absorbed in the market. Could there be a strategy of buying these new issue funds and holding for a month?

BTW I'm not advocating this, most of my funds are passive trackers.

bowlhead99

bugbyte wrote: »

Small and Mid Cap companies because of their size are likely to be disproportionally affected by large investments in their shares, so any fund buying into them is likely to create a bull run, with other investors joining in. Therefore, when a new mid / small cap fund is launched, the fund is bound to go up in the first few weeks as the new investment is absorbed in the market. Could there be a strategy of buying these new issue funds and holding for a month?

If the bolded bits were fact, not conjecture, you could be onto something.

An inflow from a new investor may not change the price. A large participation may be acquired off market in a privately negotiated transaction. The value reported to the market may not change other's views of the company as it is simply known that there was a willing new buyer and a willing seller at that price.

Even if acquired on market, the action of trying to buy a meaningful slice of the company could push the price up so that the later shares acquired by NewFund are more expensive than the earlier shares. If the fundamentals of the company have not changed and the price has risen, you will find people willing to exit, reducing the price to its original fair value once the buying pressure ceases. And some of NewFund's shares were bought for more than that original fair value. Bottom line, a new buyer can create a price move and an interest spike but generally not a sustainable bull run.

To participate in NewFund, I may redeem my interests in OldFund which operates in the same sector and actually had a larger % exposure to ABCplc. So while DEFplc experiences a net inflow, ABC being acquired by NewFund has a net outflow.

When NewFund buys a share for 200p it pays 1p in stamp duty which is lost forever and when it values the share at close of business that night it has a value of 200p and a cost of 201p. Plus broker fees etc. Does not sound good for creating a day one gain - quite the opposite.

NewFund may have launch costs that need to be absorbed somewhere in terms of a spread between buy and sell prices or an initial fee. After that, when NewFund is new and small, a running cost such as audit or legal fees or bank/broker charges will cost more per pound invested than it would five years later. This makes it costlier to invest in a small new fund than an established one.

Whether average costs are low or high compared to another fund in the market, they are always more than zero. If you buy a fund and sell a month later, you have paid for a month of administration (even though you will not be around to receive a quarter end statement or an audited annual financial report) and management decisions which may be sound but have not had the time to bear fruit. All things being equal, this cannot be efficient.

So off the top of my head there's at least 6 simple reasons why the logic of investing in new issues and immediately dumping them is flawed. I expect it would be in double figures if I thought about it properly.

Glen_Clark

Good post bowlhead.
Off the top of my head the only new fund issues I can think of which have risen in the short term are those which were highly fashionable at the time - like the European Privatisation Trusts. British Investors thought that privatisations in the rest of Europe were going to be as cheap as they were in Britain. Of course, they were wrong. No other country in the world was going to sell its power and water supplies to foreign corporations! Although the trusts rose in the initial Euphoria, they soon lost money..

srcandas

Yup great post bowlhead.

Interesting that I raised this issue of increased launch costs some time back but received zero informed response (where were you bowlhead? ).

As opposed to your approach bugbyte I was thinking that there may be a strong case to buy into a fund after the initial period with launch cost absorbed (say 3 months) rather than at launch. However when comparing launched funds against the benchmark I couldn't find evidence to support this.

Perhaps the industry has ways to spread this potential distortion?

grizzly1911

Things like this I find scary or is it just me.

http://www.trustnet.com/Factsheets/Factsheet.aspx?fundCode=0MF1S&univ=O

bugbyte_2

Thanks Bowlhead, good reply.

Linton

bugbyte wrote: »

I'm 1/2 way through reading Monkey with a Pin and to be honest it is becoming very apparent that using logic and reason to fund pick is a complete waste of time, and statistically I may as well fire arrows at the financial pages. With this in mind, could an alternative fund picking strategy work? So how about this?

Small and Mid Cap companies because of their size are likely to be disproportionally affected by large investments in their shares, so any fund buying into them is likely to create a bull run, with other investors joining in. Therefore, when a new mid / small cap fund is launched, the fund is bound to go up in the first few weeks as the new investment is absorbed in the market. Could there be a strategy of buying these new issue funds and holding for a month?

BTW I'm not advocating this, most of my funds are passive trackers.

Sorry, I disagree with much of this. Using logic, reason, and most importantly data is essential to choosing what is most likely to be an appropriate fund for your objectives and the investment style that satisfies you most. But you do have to understand your objectives and style first. Choosing a fund completely at random out of the thousands available is just silly.

Secondly, any new fund is almost certainly going to be so small that its impact on the global market will be minimal. Ok if a celebrity manager decides to set up a fund investing in something very very obscure it could have an effect but I cant see that happening.

On the general question of whether one should invest in new funds - I would say no. There is insufficient data available on what sort of things the manager will invest in (company size, industrial sectors, value vs growth etc etc) to make a rational decision.

Linton

grizzly1911 wrote: »

Things like this I find scary or is it just me.

http://www.trustnet.com/Factsheets/Factsheet.aspx?fundCode=0MF1S&univ=O

Scary?? No it looks interesting to me, at least worth finding out what it's investing in and how it has behaved over a range of different economic conditions. My long term portfolio is based on a diversified set of funds that are capable of very high growth.

One point to note is that it's in the "Specialist" sector which basically contains all the funds that dont neatly fit into any other sector. So its constituents vary considerably, and any sector average is completely meaningless.

bugbyte_2

Using logic, reason, and most importantly data is essential to choosing what is most likely to be an appropriate fund for your objectives and the investment style that satisfies you most.

I agree up to a point. Thats why we spend hours pooring over morningstar and trustnet to pick our funds. However, statistically (according to the Monkey with a pin book anyway) we are more than likely to be on a looser. One section of the book looks at share picking competitions. Using several years / competitions, the average experienced investor made 4% less than the equivalent index. Monkeys, however, tended to do better. There are lots of good reasons for this in the book.

If you think about it, Funds are essentially the market. Therefore, the average fund should perform averagely. Unfortunately, it doesn't because of several factors. In fact, only 10% beat the average. This could be down to the fees, taxes, etc. taking money out of the system; or poor funds closing / merging thus giving a healthier overall average to the fact by the time we know about something good it has already been priced into the fund.

All in all, its a bit of a depressing book really. So if we have less of a chance than chance itself of picking a top performing fund, we may as well play around with alternative strategies or stick to passive trackers.

Totton

I'd be happy to invest in a new fund if it were to be run by a respected manager using a similar strategy to one they have a proven history with. Typically you get these when a start manager moves to a new fund house and they begin with a new fund. Other than that, I've been bitten too many times by investing in a new issue only to see it disappoint - eg. Artemis Strategic Assets.

Linton

bugbyte wrote: »

......

If you think about it, Funds are essentially the market. Therefore, the average fund should perform averagely. Unfortunately, it doesn't because of several factors. In fact, only 10% beat the average. This could be down to the fees, taxes, etc. taking money out of the system; or poor funds closing / merging thus giving a healthier overall average to the fact by the time we know about something good it has already been priced into the fund.
....

But which market? There isnt just one. For large companies in a mature market a tracker will do pretty average. However in something like Small Companies the funds arent the market. Many small companies shares are tightly held by the directors, many are rarely traded and so their price is never subject to market scrutiny. Which is why most small companies funds beat the small companies index. The fund manager can examine the books of a potential investment and talk to the company management, something most investors dont have the time or access to do.

Another example is income shares. Most index funds weight on market capitalisation. Is that a sensible thing to do if you want dividends? Presumably not, I am not aware of any reasonable Income tracker fund.

Then you have the question of risk versus return. A managed fund may well slightly under perform the index but provide a very much more stable return. Which is better - the index or the managed fund? Depends on your objectives.

Final we have these random statistics thrown out - eg only 10% beat the index. Let have a look at the Trustnet 10 year data for UK All share Equity: if only 10% of funds manage to beat the average (presumably the index) you would surely expect to see the trackers edging their way up to near the top of the rankings after 10 years. You dont - the trackers stay around the middle.