Far too many 401(k)/403(b) plan sponsors, trustees, and other investment fiduciaries leave themselves unnecessarily exposed to personal liability due to the selection of cost-inefficient investment options. The Active Management Value Ratio is a simple, yet powerful, metric that allows fiduciaries to quickly determine whether an actively managed mutual fund is cost-efficient and, therefore prudent under applicable fiduciary standards.

1. INVESTSENSE
THE ACTIVE MANAGEMENT VALUE RATIO™:
MINIMIZING FIDUCIARY RISK
JAMES W. WATKINS, III, J.D., AMVR®
INVESTSENSE, LLC

2. INVESTSENSE
Risk Management and the AMVR
Recent ERISA court actions have argued
over the proper way to evaluate mutual
funds, including comparisons over funds’
> business platforms
> annualized returns
> expense ratios
> assets under management
> popularity

3. INVESTSENSE
Risk Management and the AMVR
“[t]he best way to measure a manager’s
performance is to compare his or her return
with that of a comparable passive alternative.”
Nobel Laureate William F. Sharpe

4. INVESTSENSE
Risk Management and the AMVR
“So, the incremental fees for an actively
managed mutual fund relative to its
incremental returns should always be
compared to the fees for a comparable
index fund relative to its returns.”
Charles D. Ellis

5. INVESTSENSE
Risk Management and the AMVR
The Active Management Value Ratio™
(AMVR) ignores all the irrelevant collateral
issues and focuses on what really matters
– the cost-efficiency, or the true benefit, if
any, provided to investors.
The AMVR essentially says “I don’t care
how you did it, but whether you actually
provided a real benefit to me at all.”

6. INVESTSENSE
Risk Management and the AMVR
The following slides explain how investors
can interpret the AMVR calculation process
and use the AMVR as a wealth
preservation tool.
The two funds shown on the slides are two
of the most popular mutual funds in terms
of invested assets, both in terms of retail
shares and retirement shares/401(k) plans.

7. Fees AER
Annualized
Return
Active Fund
Expense Ratio 0.64 5.40 15.47 Nominal
14.11 Load Adjusted
12.94 Risk Adjusted
Benchmark
Expense Ratio 0.17 0.17 15.34 Nominal
14.06 Risk Adjusted
IC/IR 0.47 5.23 (1.12)
% Fees/% Return 73% 96% NA

8. AMVR Annualized Returns
The AMVR examines three types of returns:
1. Nominal, or stated, returns.
2. Load-adjusted returns, showing the impact
of any front-end fees charged by a fund.
3. Risk-adjusted returns.
AMVR uses risk-adjusted returns in its
calculations. Here, the fund failed to even
provide a positive incremental return.

9. INVESTSENSE
Fees AER
Annualized
Return
Active Fund
Expense Ratio 0.64 5.40 15.47 Nominal
14.11 Load Adjusted
12.94 Risk Adjusted
Benchmark
Expense Ratio 0.17 0.17 15.34 Nominal
14.06 Risk Adjusted
IC/IR 0.47 5.23 (1.12)
% Fees/% Return 73% 96% NA

10. INVESTSENSE
AMVR Nominal Fees
The AMVR uses a fund’s annual expense
ratio, but not the fund’s turnover/trading
costs in calculating a fund’s total costs.
While trading costs are factored into a
fund’s stated return as part of a fund’s
operating costs, they are not broken out
separately, preventing investors from
comparing such fees for each fund.

11. INVESTSENSE
AMVR Nominal Fees
Since funds are not legally required to
provide investors with the fund’s actual
trading costs, the InvestSense
recommends that investors and fiduciaries
use a metric created by John Bogle as a
proxy for such costs.
Trading costs = (fund turnover x 2) * 0.60

12. INVESTSENSE
AMVR Nominal Fees
Bogle’s metric allows investors to compare
the efficiency of the management of two
funds. If two funds have comparable
annualized returns, but the trading costs of
one of the funds is twice that of the other
fund, that is information that most
investors would find valuable. As Mr. Bogle
often said, “costs matter.”

13. INVESTSENSE
Fees AER
Annualized
Return
Active Fund
Expense Ratio 0.64 5.40 15.47 Nominal
14.11 Load Adjusted
12.94 Risk Adjusted
Benchmark
Expense Ratio 0.17 0.17 15.34 Nominal
14.06 Risk Adjusted
IC/IR 0.47 5.23 (1.12)
% Fees/% Return 73% 96% NA

14. INVESTSENSE
AMVR AER-Adjusted Fees
The AMVR also calculates a fund’s fees
using Ross Miller’s Active Expense Ratio
(AER) metric. The AER reveals the implicit
cost of a fund’s active management
component and helps investors avoid
potential “closet” index funds, funds that
closely track comparable indices and/or
index funds but charge much higher fees.

15. INVESTSENSE
Fees AER
Annualized
Return
Active Fund
Expense Ratio 0.64 5.40 15.47 Nominal
14.11 Load Adjusted
12.94 Risk Adjusted
Benchmark
Expense Ratio 0.17 0.17 15.34 Nominal
14.06 Risk Adjusted
IC/IR 0.47 5.23 (1.12)
% Fees/% Return 73% 96% NA

16. Calculating the AMVR
InvestSense calculates a fund’s AMVR
score by dividing a fund’s AER-adjusted
incremental cost by the fund’s risk-
adjusted incremental return.
The goal is an AMVR score between one
(1) and zero (0). This indicates that a fund
is cost-efficient, that the fund’s costs were
less than the fund’s returns

17. INVESTSENSE
Fees AER
Annualized
Return
Active Fund
Expense Ratio 0.74 5.48 15.47 Nominal
14.81 Risk Adjusted
Benchmark
Expense Ratio 0.17 0.17 15.34 Nominal
14.06 Risk Adjusted
IC/IR 0.57 5.31 0.75
% Fees/% Return 77% 96% 5.0%

18. INVESTSENSE
Calculating the AMVR
The AMVR requires an investor to ask two
preliminary questions:
1. Did the fund provide a positive
incremental return?
2. If so, did the fund’s incremental return
exceed its incremetnal costs?

19. INVESTSENSE
Calculating the AMVR
If the answer to either question is “no,” the
fund is not cost-efficient and no AMVR is
needed
The InvestSense AMVR formula:
AMVR = AER-Adjusted IC/Risk-Adjusted IR
Using our second example fund:
Nominal AMVR = .57/.75 = 0.75
AER-adjusted AMVR = 5.31/.75 = 7.08

20. INVESTSENSE
Calculating the AMVR
This is a perfect example of why we advise
investors and fiduciaries to always factor in
the impact of a fund’s correlation factor, or R-
squared number, as it more accurately
reflects a fund’s costs and helps expose
potential “closet index” funds. Closet index
funds are funds that claim to provide active
management to explain their higher fees, but
actually provide similar, or lower returns, than
comparable, less expensive, index funds.

21. INVESTSENSE
The Cost-Efficiency
Quotient
The Cost-Efficiency Quotient (CEQ) is an
proprietary metric of InvestSense that
examines a fund’s cost-efficiency.
In our example:
- Nominal CEQ shows that 74% of fund’s
fee only producing 5% of the fund’s return.
- AER-adjusted CEQ shows that 96% of
fund’s fee only producing 5% of the fund’s
return.

22. INVESTSENSE
The InvestSense Quotient
InvestSense also uses a proprietary
metric, the InvestSense Quotient (IQ),
which measures the overall quality of
performance of an actively managed fund
based on the fund’s efficiency, both in
terms of cost and risk management, as
well as the fund’s overall consistency of
performance.

23. INVESTSENSE
AMVR vs. IQ
The difference between the AMVR and the
IQ is that AMVR is a quantitative metric,
while the InvestSense Quotient is more of
an overall qualitative metric.