6. Mutual Funds - Performance Measurement
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6. Mutual Funds - Performance Measurement

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6. Mutual Funds - Performance Measurement 6. Mutual Funds - Performance Measurement Document Transcript

  • 6. Mutual Funds - Performance Measurement Professional Referrals -- Financial Planning - Your Investments - Investment Products -- Investment Products 6. Mutual Funds - Performance Measurement Friday 12 December 2003 Résumé : There are four major selection criteria to consider when choosing a mutual fund and evaluating its management. Professional Referrals Page 1/5
  • 6. Mutual Funds - Performance Measurement There are hallmarks of good fund manager's performance that transcend the quarter-by-quarter fluctuations in the value of a fund. Some funds, like index and money market funds are evaluated on their ability to track their respective markets and allow a somewhat passive management style; others, due to their fund type require a more active involvement in the continuing management of the fund investments. There are four major selection criteria to consider when choosing a mutual fund and determining whether its return is reasonable, given market conditions and the type of fund: • Annual performance of the fund, excluding the affect of compounding, • Fund management expense and management expense ratio (MER), • Volatility of the monthly rate of return, and • The fund's rank by quartile. When looking at a fund's track record, consider annual rather than compound performance. While compound performance illustrates the effect if an investor bought the fund and held it over time, annual returns show the returns of each year separately. Displaying each year's annual results separately exposes those years in which the fund posted negative returns. If negative returns are embedded in the 3 or 5 year aggregate, it is more difficult to judge performance and risk. There are other fees associated with mutual funds, in addition to sales or redemption charges that an investor must pay. The management fee is the fee paid to the manager for investment management services and is normally a percentage of the net asset value of the fund. Usually, the lowest management fees are found for index and money market funds, for which there is less active selection than for an equity fund. These charge the lowest among the fund families, usually around 1%. The management expense ratio (MER) is the ratio of all fees paid by the fund to assets under management, including custodial services, trading fees, and unit holder communications. The management expense ratio is always deducted before the return is calculated. Mutual funds are required to disclose both the management fee and the management expense ratio for the past five fiscal years in the fund's prospectus. When evaluating a potential mutual fund purchase, compare the management expense ratio with other funds of the same or similar category. The size of a fund can influence its ability to out perform its peers. Tremendous growth in returns from investments in small capitalization companies can substantially influence a small fund's returns, whereas the same performance when held in a larger fund will have less overall impact in total fund performance. Although both small and large funds can invest in the same companies, the larger fund's overall returns will be less affected by extraordinary growth in one or a few individual Professional Referrals Page 2/5
  • 6. Mutual Funds - Performance Measurement companies, since the investment is too small to make an impact. On the other hand in some markets, such as the bond market, larger participants have an advantage through domination, access to new issues, or superior pricing. A fund's volatility relative to other funds can be measured by its standard deviation of monthly returns. Standard deviation measures the variability of historical returns to determine the likelihood of future returns. A fund's standard deviation is expressed as a number and represents the likely range of fluctuation above and below a fund's average return. Rankings are used to distinguish lower risk funds from higher risk funds. Mutual fund performance is usually ranked by quartile, with performance measured against similar types of funds. Both annual and compounded returns are available, so it's possible to see the affect of a continuous year-over-year investment as well as the annual, yearly performance history. Returns are quoted exclusive of management expenses. The quartile ranking system is used to evaluate a fund manager's performance against others in the same market: First (top) quartile Top 25% of performers Second quartile Next 25% of performers Third quartile Next 25% of performers Fourth (last) quartile Last 25% of performers Funds with consistent ranking in the upper quartiles may have better fund managers and will generate more wealth over time for fund holders. Although it may be tempting to follow outstanding performance, investors should avoid switching funds to be invested with the most recent first quartile fund managers, unless they are consistently high performers. The quartile ranking system above is particularly useful for comparing a fund manager with its peers. When choosing a fund manager, an investor should consider factors other than the most recent year or quarter's performance. Instead, an analysis should focus on the fund's long-term performance, how long they have managed the fund, and the consistency of returns over time. Professional Referrals Page 3/5
  • 6. Mutual Funds - Performance Measurement Professional Referrals Page 4/5
  • 6. Mutual Funds - Performance Measurement Mutual Fund Statistics - IFIC Members Year Assets (billions $) # of Funds # Accounts (thousands) 1999 389.7 1382 45,752 1998 326.6 1030 40,948 1997 283.2 1023 32,826 1996 211.8 954 22.297 1995 146.2 916 15,295 1994 127.3 813 13,486 1993 114.6 633 8,928 1992 67.3 543 5,514 1991 49.9 505 4,533 1990 24.9 422 2,587 Professional Referrals Page 5/5