Deciding what to do with your money is the essence of the fund manager's job. Make the right decisions and everyone is happy - including the manager, who can expect a handsome bonus at the end of the year. Get it wrong and the fund will slide down the performance tables, losing business on the way. The process of deciding where to invest is known as asset allocation. In tracker funds, which follow the performance of a particular stock market index, it is comparatively simple: the fund either invests in all the shares that make up the index, or a representative sample. With active management, it is another story. Methods differ and there are few hard and fast rules but the starting point will be the nature of the fund and its area of operations Both unit and investment trusts are grouped in sectors. Some sectors are geographic (the UK, Europe or Far East); some are defined by objectives, in terms of income or capital growth; others are defined by the nature of their investments - for example, smaller companies or property shares.In many of the larger fund management groups there is a house policy, which determines the framework within which fund managers should operate.
This is generally decided at board or senior management level, based on economic and market forecasts, which may not be in line with consensus.To take one example, Phillips & Drew Fund Managers achieved considerable publicity, some would say notoriety, last year for increasing the proportion of its funds held in cash, rather than shares. This policy was based on a strongly held conviction by Tony Dye, the firm's investment supremo, and his senior colleagues that stock markets on both sides of the Atlantic were set to slide.While PDFM professes not to be embarrassed that the markets have continued to climb, believing that the bears are still lurking around the corner, the policy has been the source of much public comment and more than a few smiles in its competitors' private dining rooms.In the case of international funds, houses will usually have country weightings, which determine the proportion of funds to be invested in each market.So fund managers investing in continental Europe may well be underweight in Italy, because of political uncertainty, while a number of Asian funds have reduced their Thai holdings because of concerns about the economy and prospects for the local currency, the baht.But there has been no sign of a flight from Hong Kong before the handover to China. Seasoned China watchers believe Peking is determined not to imperil Hong Kong's success, and are describing it as "the New York of the new China". Philip Saunders, a director of Guinness Flight, which has launched a unit trust to invest in the region, says: "Hong Kong is already playing a pivotal role in China's emergence as an economic superpower." His view is echoed by other fund managers, who are increasing Hong Kong holdings.Finally comes stock-picking: the point at which a fund manager examines the performance of specific companies to see if they match his criteria for investment. This can be likened to a series of filters, generally based both on financial performance and prospects, and on the outlook for specific business or industrial sectors.Financial filters can relate to such factors as gearing (the level of borrowing relative to shareholders' funds) and profitability. While companies that are highly geared may well earn good profits, some fund managers think that the management will be spending too much time talking to their bankers and not enough on the business.Most funds lay down strict financial criteria. And however promising the prospects for a specific company may be, if it fails to clear these hurdles, it will not qualify for the shortlist.Sector filters can be positive or negative.
At Invesco, for example, Claire Griffiths, who runs the pounds 70m European Smaller Companies fund, highlights luxury goods manufacturers and knowledge-based businesses as particularly promising performers, but keeps a strict cap on holdings in "glamour" sectors such as biotechnology, because of the risks and volatility.Not many of us have the time, the skills, or indeed the inclination to investigate fund managers, but it is worth paying some attention to the details of where and how a fund invests.If you are planning to invest through a PEP you need to be aware of the limits on qualifying investments. These are generally seen as limiting investors to UK and European funds, apparently ruling out some of the international growth opportunities.With planning and fund selection, however, it is possible to end up with 60 per cent of your PEP invested internationally.. Unless you have the gift of prophecy, a punt on company shares does not make a lot of sense without the money to build up a sizeable portfolio. Few people have the foresight of Nostradamus, which is one of the reasons why pooled investments are so popular. The principle is straightforward: if a lot of people put their money together and invest as a group, they can buy a wide range of shares and spread the risk. This form of investment is extremely popular. There is more than pounds 138bn invested in unit trusts, the UK's most popular form of pooled investment. But their much older cousins, the investment trusts, have attracted pounds 48bn and offer an attractive alternative.An investment trust is a company that has its shares traded on the Stock Exchange.
Instead of making hair spray or running airlines, investment trusts buy shares in other companies. Their profits come from the dividends paid on the shares they own and the gains they make from buying and selling shares.Every investment trust has to publish an annual report and accounts that will spell out its investment strategy. That might involve aiming to generate income, specialising in a particular industry or focusing on a geographical area. The aim of the trust is usually found in its name; no prize for guessing what the Ivory Sime UK Smaller Companies trust invests in.The best-performing trusts have done well for investors. According to Chase de Vere, the financial advisers, pounds 1,000 invested in the top-performing Murray Enterprise trust five years ago would now be worth pounds 4,621.72. That, of course, is no guarantee of what might happen in future.Up to pounds 6,000 of an investment in most trusts can be placed in a personal equity plan, which means that any dividends or capital gains are tax-free.