How 2014's Rated Funds were chosen

Investors face a bewildering choice of more than 2,300 funds and 300-plus investment trusts when deciding where to put their hard-earned money. For many, the choice boils down to finding a top-performing fund over the past year or three years, and perhaps looking for the added reassurance of a couple of star ratings next to the fund's name.

Money Observer's Rated Funds system aims to take the guesswork out of this important investment decision by narrowing down the choice to a shortlist of consistent strong performers.

Demystifying official sectors

Our starting point in the Rated Funds process is to create specific asset class groups to categorise member funds that can be clearly understood. This helps to demystify investment options for private investors. Also, because we consider open-ended funds and closed-end investment companies (investment trusts) for our Rated Funds, the official sector names are not always appropriate and can be baffling.

An example of potential confusion is the Investment Management Association's (IMA) three mixed investment sectors, where funds can appear in "0-35% shares", "20-60%" shares or "40-85%" shares sectors. We define these categories more simply as "mixed asset - lower risk" and "mixed asset - higher risk".

But there are two other IMA fund sectors which also fall into these two categories - flexible investment, and UK equity & bond income. And there is no official sector for investment trusts that adopt a mixed-asset mandate - such as RIT Capital Partners or Ruffer Investment Co, both of which invest in a range of asset types.

They too are therefore consigned to our mixed asset categories.

The other Rated Funds categories we adopt are fairly easy to understand: global emerging markets, global bonds, UK bonds, UK smaller companies, commodities, property, global equity and global equity income. For those who want specific regional exposure to equities we have grouped our developed market Rated Funds into the following sectors: Japan, North America, Europe (some Rated Funds may also include the UK).

There is also a specialist Rated Funds sector, which captures anything from biotechnology to clean energy. Within all of these sectors we've also tried to identify at least one Rated Fund that could be regarded as adopting ethical or socially responsible principles.

How we select the Rated Funds

Our first port of call is to include any fund or trust that is a member of the 12 Money Observer Model Portfolios (where gains range up to 52% after two years to 1 January 2014). If they're in these portfolios, they are "rated" by us.

These Model Portfolios are tradeable as single entities on Interactive Investor. Most of the funds and trusts in our Model Portfolios have one thing in common with the majority of Rated Funds - they have delivered consistently good returns.

That means they will have been eligible for the Money Observer annual fund and trust awards; for inclusion in our occasional "Consistent 50" fund rankings; and also for our Premier League of funds.

We also select funds and trusts we believe are relevant for current market conditions. This means we may raise or lower the number of Rated Funds in sectors we think are more or less attractive to investors.

This year, for example, we have reduced the number of fixed-interest funds - in some instances because their yields have become unattractively low but also because we believe private investors are more interested in seeing an expanded list of Rated Funds in other areas, such as North America and Europe.

Monitoring Rated Funds

We first introduced the Rated Funds concept a year ago but because our initial range was only around 100 we added to the original list throughout the year.

This year, however, we do not currently plan to add any more funds and trusts beyond finding replacements for any constituents that need to be replaced due to manager changes, takeovers or disastrous performance against a peer group.

Changes since 2013

We've removed 53 funds and trusts - but only 11 are due to poor performance. Among funds these are Aberdeen World Equity, Ecclesiastical Amity International, Fidelity Moneybuilder Growth, Insight Absolute Insight, Jupiter Merlin Income, Liontrust UK Growth, Marlborough Defensive and Troy Spectrum.

Investment trusts that have not lived up to our expectations are British Empire Securities & General Trust, HarbourVest Global Private Equity and HgCapital.

The remaining 42 constituents have been removed for various other reasons. These include where a fund has effectively closed to new investment or a trust's share price premium to net asset value has become too high; where we have culled the constituents of a Rated Funds group (such as global emerging markets); or where we have decided the investment remit is too specific for current conditions.

Why are there still poor performers in the 2014 list?

Some of this year's Rated Funds could be classified as poor performers - because the asset class is out of favour or because the fund's strategy has not delivered.

Investors in Templeton Emerging Markets investment trust, for example, have good reason to be disenchanted about its recent performance. However, we are prepared to stick with this investment trust.

As an example of how it can pay to stick with a strategy, longer-term investors in Legal & General UK Alpha can now celebrate after a poor 2012, because the fund (which we included in one of our Model Portfolios) returned 43% in 2013.

What's in the tables?

The tables show the industry sector each constituent (fund or trust) belongs to; its net yield; three-year performance and rank in its industry sector; discrete annual performance over each of the past three years to 1 February; and its industry sector rank in each of those years.

We also quote FE Risk Scores, which shows how risky an investment is relative to the FTSE 100 index (UKX). Shares in the index are regarded as comparatively defensive, although they do of course fluctuate. Investments more volatile than the FTSE 100 have a score above 100 and vice versa, giving a reliable indication of relative risk.

It is not a measure of absolute risk. The data was sourced from FE Trustnet as at 1 February 2014. See moneyobserver.com for current performance and factsheets.

The data in these tables was sourced from FE Trustnet as at 1 February 2014.

This article is for information and discussion purposes only and does not form a recommendation to invest or otherwise. The value of an investment may fall. The investments referred to in this article may not be suitable for all investors, and if in doubt, an investor should seek advice from a qualified investment adviser.