Suppose that a mutual fund, Washington Peak Strategic Bond Fund, believes it has hit upon a winning investment strategy.The fund uses an active management strategy to try to outperform the bond market

Question

According to Washington Peak's prospectus, investors need to pay fees of 2 percent annually.Based on the historical success of their active investment strategy, the strategy is projected to generate annual returns (once fees are paid) of 8 percent. A friend of yours is considering investing in Washington Peak and asks you for investment advice. What would you suggest?

Answer 1

One of the problems with Washington Peak's investment strategy is the lack of diversification. By investing most of the fund's money in one investment strategy, Peak will not be able to diversify its returns. It should therefore not be a large fraction of your friend's total investment portfolio.Second, Peak's traders base their strategy on historical data. It is not necessarily the case that historical trends will continue to play out in the future. This fact introduces some additional risk.The third factor that your friend will need to consider is the expense ratio that Washington Peak is charging. An expense ratio of 2 percent is generally considered to be very high for a mutual fund. High expense ratios lower the net annual return that your friend receives on his investment.
A-head:RISKY RETURNS; DIVERSIFICATION; INVESTMENT ACCOUNTS
Concept: Diversification, expense ratios