5 Best ISA Fund Buys According to This Online Broker’s Volatility Rating

When assessing the performance of a fund, most investors will look at returns generated over the medium to longer term. Those investing online in an ISA will often feel confident that returns generated over a 10-year period are a strong indicator of a fund’s likely future performance. However, the professionals are not ready to fully trust historical performance even over ten years as an indicator of a fund’s future potential.

Funds can deliver strong returns as result of a small number of investments handsomely paying off. However, in some instances this can be down to a good dash of luck and not as much of an indictment of the fund manager’s talent as may be though. If returns are generated or considerably improved as a result of some lucky breaks, the chances of that success carrying on into the future is of course slim.

So how do professionals further de-risk the chance of historical returns being matched in the future when rating them? Online stock broker AJ Bell uses an ‘information ratio’ which also measures the volatility of funds. The broker uses an analysis tool called FE Analytics. Morningstar and Trustnet are other services offering similar volatility data analysis that anyone investing online can use themselves to rate funds.

The logic behind using an ‘information ratio’ is that measuring a fund’s returns against its volatility isolates those that have shown consistency. This indicates returns have been generated from a wide variety of balanced investments rather than a few lucky hits. Ryan Hughes, AJ Bell’s head of fund selection explains:

Put simply, it shows whether the fund manager’s active bets have paid off over the long term. Fund managers can get lucky with stock picks in the short term, but it’s far more difficult to stay lucky. Those who have a good information ratio over the long term show skill in stock selection. It’s a good way to separate two funds that have achieved similar returns in very different ways”.

AJ Bell targets an information ratio of more than 0.5%. That’s considered good and anything above 1 excellent. So based on AJ Bell’s information ratio approach, which funds does the online stock broker recommend for an ISA? Here’s the top 8:

Stewart Investors Asia Pacific Sustainability charges 0.98%, has a 10-year annualised return of a whopping 14.9% and the extremely impressing information rating of 1.54%. The fund invests in companies considered likely to benefit from sustainable development.

Lindsell Train UK Equity has delivered annualised returns of 16.7% over 10 years and has an information ratio of 1.26%. Annual charges are 0.7% and the strategy of manager Nick Train is to buy and hold high quality stocks whose business he believes will still be strong in 50 years.

Fidelity UK Smaller Companies a 10-year annualised return of 19.6% against an information ratio of 1.2%. This fund’s strategy is firmly contrarian and the biggest investments in the industrial, consumer and finance sectors.

Man GLG Continental European Growth has a 10-year annualised return of 14% against a 1.15% information ratio. As the name would suggest this fund focuses on European companies with its largest holdings coming from Ireland, Germany, Italy and Denmark with at least 10% each.

Liontrust Special Situations has recorded ten-year annualised returns of 15.4% and an information ratio of 1.11%. Large UK businesses with pricing power are the main focus of the fund but around a third is also allocated to mid-caps.