Simple Pound

The last two posts in this series were rather theoretical so I decided to give it a more practical twist by actually comparing two funds with each other to decide which seems the better choice.

I decided to take two UK Large-Cap equity funds. The first is the Fidelity MoneyBuilder UK Index Fund and I will compare it to the Legal & General Growth Trust. Both funds are selected more or less randomly (Fidelity and L&G were the first fund managers that came to mind).

Morningstar Category.
So, let’s get started. The first thing to check in order to guarantee a well-balanced and diversified portfolio is the Morningstar Category. This is UK Large-Cap Blend Equity in both cases, so we know that whichever fund we’ll pick our portfolio have some exposure to the UK market and more specifically UK companies with a large market capitalisation. This provides a good foundation because large-cap companies are generally established companies that provide stable and reasonably reliable returns.

Returns.
Next, we’ll have a closer look at the fund’s returns in the past 3 years. To do this, we need to have go to the fund’s subsection “Risk & Rating” (Fidelity, L&G). Fidelity’s mean return based on the last 3 years stands at 19.42%, which means that on average your money increased in value by 19.42% per year. Legal & General on the other hand offers an average return of 27.27% per year. If you want to get a better idea about the actual returns per year in the recent past, the subsection “Total Returns” will provide you with exactly that (Fidelity, L&G). Here we can see that Fidelity achieved a growth of 16.50% in 2006 and a growth of 8.49% in the first 5 months of 2007. Compared to L&G who grew by 29.53% in 2006 and 15.52% in 2007 so far, Fidelity clearly loses out. Overall, Legal & General’s fund is in a better position in terms of returns.

Volatility.
The investor who is looking for long-term returns should be willing to sacrifice some returns for lower volatility as this will generate higher capital growth in the long run. Therefore we look at volatility next. To do this, we need to return to the Risk & Rating section. Fidelity’s mean volatility for the last 3 years equals 7.61% which means that most of the time (in 66% of the cases should you really want to know) the fund’s returns were somewhere between 11.81% and 27.03% (19.42% +/- 7.61%). Legal & General on the other hand had a standard deviation of 10.02% leaving the returns somewhere in the range of 17.25% and 37.29%.

This is the first time the comparison gets a little tricky, because you have to decide for yourself whether you want to stomach the extra risk the L&G fund brings in return for higher growth. L&G’s volatility is 30% higher than the Fidelity fund, but their returns exceed Fidelity’s on average by 40%. Therefore I think L&G seems to be the better fund (if only slightly) in this category as well.

Costs.
The next criteria to look at concerns the fund’s management fees and thus the costs that will bring your net return down. From the return & volatility analysis above I would suspect the L&G fund to be more expensive, but let’s have a look. Head over to the “Fees” section at Morningstar to get an overview of their fees (Fidelity, L&G). The good news is that neither of the funds has an initial charge, which means that the full amount of your investment will work for you (as opposed to, e.g. 95% for you, 5% for the fund managers). Fidelity’s fund is an index tracker fund (as the title suggests) and therefore the management fees are extraordinarily low at 0.10%. Therefore you got an average net return of 19.32% in the last 3 years with Fidelity.

Legal & General’s fund is actively managed and hence has higher management fees of 1.50%. Based on my experience, this is about average for actively-managed funds but you have to know for yourself whether or not you are willing to pay 1.50% of your investment for 40% higher returns (in this case). Theoretically, your net return with the L&G fund would have been 25.77% on average in the last 3 years. In practice, however, you will have to pay an exit charge of 5% when you sell this fund which will obviously diminish your returns. Therefore, I’d say that Fidelity’s fund clearly wins the race in terms of associated costs.

Risk.
Having already considered the volatility of the two funds, let’s return to the subsection Risk & Rating to compare the fund’s risk to the overall category. The results aren’t really surprising and show that Fidelity has a just average risk exposure compared to all the UK Large-Cap Blend Equity funds, while L&G’s risk is higher than many other funds. Again, you will have to decide for yourself whether or not you want to have this extra risk in your portfolio and whether the extra return the fund gained in the last 3 years is sufficient to balance the additional risk.

Bear in mind that the stock market doesn’t always go up though and that you will have to re-balance your portfolio once a year no matter how the individual assets performed in order to make best use of the asset allocation principles. Thus, I think that Fidelity is the better choice for long-term, risk-averse investors while L&G has its place in more aggressive portfolios.

Fund objectives.
Back to the overview page to find out more about the funds’ investment objectives. We already worked out that the Fidelity fund is an index tracker fund, therefore it is not surprising to find the following objectives:

The fund aims to achieve long-term capital growth by matching the performance of the FTSE All Share Index as closely as possible, with the minimum of tracking error.

L&G on the other hand has the following objectives:

The investment objective is to secure capital growth by investing in a portfolio principally of UK shares. Securities of companies with strong growth prospects will be chosen.

This shows that the Morningstar category doesn’t necessarily reflect the L&G fund accurately as I would have put it into the Growth category instead. While the growth fund seems attractive and potentially more lucrative than an index fund, market efficiency shows that growth stocks won’t grow indefinitely and that value stocks actually outperform the market in the long run.

Any diversified portfolio should have exposure to both categories to ensure both stability and as well as a decent growth and hence capital appreciation, but with objectives like this I would not choose the L&G fund as a portfolio base but rather as an addition to get some more exposure to growth funds. I’m quite pleased that I could demonstrate how important the funds’ objectives are when deciding whether or not a particular fund is right for you.

Morningstar Style Box.
The last but one criteria to consider is the Morningstar Style Box, which can be found on the fund’s overview page. With a category name like “Large-Cap Blend Equity” I would expect to find both funds with a style box combination of “Large” and “Blend”. However, Fidelity deviates from this with a style defined as Large-Value. L&G on the other hand, which I would have associated with Growth, has a Large-Blend style in line with the category.

To be honest, I find this a little confusing because I would prefer a “Large-Blend” fund as a portfolio base but at the same time I am convinced that the L&G fund is unsuitable for this. Hence to gain more clarity, this would be the point at which I would switch to the “Portfolio” section (Fidelity, L&G) to have a closer look at the fund’s asset allocation.

Morningstar Rating.
And finally, the Morningstar rating tells us that Morningstar deems the L&G fund (5 stars - top 10%) to be better than the Fidelity fund (4 stars - top 32.5%). Here the word “better” is somewhat controversial as it clearly depends on the purpose we think the fund should have.

As I have implied earlier, the overall conclusion I would take away from a comparison like this, is to use the Fidelity tracker fund as a solid base for the portfolio which can then be enhanced by additions like the L&G which will provide the portfolio with more aggressive growth exposure. In fact, by looking at the Portfolio section of the L&G fund it becomes obvious that a high percentage of the fund is invested in mid-cap stocks, which are inherently riskier and more volatile. This proves my “gut feeling” of not relying on the L&G fund to provide steady and reliable returns.

I hope you found this comparison useful despite the lengthy nature of the post. If there are any more questions with regards to Morningstar and/or fund comparison, please get in touch either by leaving a comment or by contacting me directly!

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