I gave a short presentation at the Mello Trusts & Funds event on 15 May 2019.  It set out Fund Hunter's objective and the case for funds.

There are cat people and there are dog people.  There also tends to be fund people and stocks people.  In my view, this is misguided.

Funds can allow stock investors to perform well through a core/satellite approach.

Funds are also the easiest way to invest.  They offer instant diversification and access to global markets.

There are some excellent funds out there. Fund Hunter's objective is to find the best funds.

Fund Hunter Mello presentation

Mello 2019 Trusts & Funds presentation - How to invest in funds

The full presentation is available here:

MelloMay2019

What exactly was I trying to say?

1) First define the problem we are trying to solve

We want to maximise our return while keeping the chance of a large and permanent loss of value at zero.  This is the investment problem we are trying to solve.

2) How to solve problems

The best solution to a problem tends to be the simplest one.  This thesis is known as Occam's razor

3) Funds reduce risk and are a simple solution

Funds offer instant diversification, which reduces risk.  They are also a simple way to invest.

4) Funds generate high returns if they benefit from compounding

Einstein called compounding the eighth wonder of the world.  He is reported to have said the following when it comes to compound interest:

Compound interest is the eighth wonder of the world. He who understands it, earns it ... he who doesn't ... pays it.

Compound interest is the most powerful force in the universe.

Compound interest is the greatest mathematical discovery of all time.

5) Stocks can compound better than any other asset class

This has been known for some time but was clearly explained in a Financial Times article by Terry Smith.  Equities are the only asset class that can reinvest at a high rate of return.

A company with a return on equity of 80% may be able to reinvest earnings at this rate.  This is something that is very valuable and allows equities to compound in value.

6) The best funds own stocks that can compound i.e stock compounders

Not all stocks are able to compound in value.  I refer to companies that are able to do as "stock compounders."

These are companies that A) generate high returns B) sustain high returns and C) realize high-return growth.

They deliver strong earnings growth and should be relatively low risk.  A prominent example is the UK investment platform Hargreaves Lansdown.

Over the long-term, share prices move in line with earnings per share.  The scope of stock compounders to grow earnings will therefore lead to share price momentum.

Hargreaves Lansdown is a classic stock compounder

Source: SharePad

7) Funds that own stock compounders 

The funds that perform best own stock compounders.  Other routes to investment success are much harder to make work.

Funds with a high concentration of stock compounders include the S&P 500 index, Fundsmith Equity Fund and the Lindsell Train Global Equity Fund.

8) Different types of stocks

We can categorize stocks as A) compounders B) rebounders and C) blow ups.  Stock compounders are rare as recent research makes clear.

Most investors focus on rebounders.  This appears to be logical.  However, it is harder than it seems to perform well by investing in "cheap stocks."

Blow up stocks are the third category we need to focus on.  It is not enough to own winners we must also avoid losers.

The research shows that a significant proportion of listed companies fail to create value: Do Stocks Outperform Treasury Bills.

It is easy to forget that to do well we need to avoid disasters.  Low risk funds tend to outperform high-risk funds by avoiding blow-up stocks.

Fund Hunter's approach

The website seeks to have a clear process when it comes to fund selection.  This is the key to investment success.

1) About Fund Hunter

The objective of Fund Hunter is to identify the best investment funds.

This will be achieved by learning how they invest.  The second stage is to look at stocks in the fund and in general.

If we are looking for funds that own stock compounders we need to analyze stocks.  Good funds own good stocks.

The website operates as a subscription service.  This helps preserve the website's independence.

2) Fund selection process - Where, how, who

Fundsmith has a three-stage process to selecting stocks.  It makes sense to have a three-stage process to selecting funds. The three criteria are in order of how they should be evaluated.

A) Where a fund invests is the most important criterion.  It is hard to perform well if a fund invests in an area that is unlikely to perform well.

B) The next criteria to look at is how a fund invests.  I prefer funds to own stock compounders and look for investment approaches that achieve this.

C( The final criteria is who is running the fund.  This tends to be where most people covering funds start.  But it is the least important of the three.

A great investor won't perform if they are focused on a lousy market and adopt a weak investment approach.

3) Look at all the funds that are available

It is remarkable that many investors rule out certain types of funds.  It is hard to see how this can be rational.  The more options we have the better choices we are able to make.

Fund Hunter looks at active funds, passive funds and all the main fund structures.

Some investors will only look at active funds or passive funds.  A number of investors will also only consider certain fund structures such as Investment Trusts.

The active versus passive fund debate is a contentious one.

Active funds are only worth considering if they can outperform the next best passive alternative.  There are in my view some active funds that appear to add value.

A rational approach is what matters.  Our starting point is therefore to consider all of the fund options that are on the table.

4) Focus on the best funds

It has sometimes been said that there are more funds than stocks.  This may not be true, but there are certainly more funds than we have use for.

Most active funds fail to outperform.  Fund Hunter, therefore, seeks to focus on the top 1% of funds (active and passive).

Funds are like stocks.  We only need a few good ideas to perform well.

A good example of this is the Lindsell Train Investment Trust (LTI).  The fund's stake in the fund manager Lindsell Train Limited has enabled it to deliver market-beating returns.

5) Fund Hunter Model Portfolio of funds

Fund Hunter runs a model portfolio.  This offers a way to evaluable the approach against the UK All-Share Index.

It is an interesting challenge to see if this index can be beaten.  The year-to-date return of the model portfolio is 17.8% versus 10.5% for the All-Share index.

Fund Hunter portfolio against the All-Share index year to date

Source: SharePad

Summary

The investment problem is to maximise returns while the risk of a large and permanent loss of value remains at zero.

Funds are the simplest way to solve the problem.  They reduce risk and offer the potential for high returns.

To maximise our return we need to invest in funds that own stock compounders.

Fund Hunter's objective is to find the best investment funds.