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Evaluating Mutual Fund Performance

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Therefore, total return from a mutual fund for a given year is determined by the ... Based on Washington Mutual Investors Fund's NAV (Fig. 5.3) ... – PowerPoint PPT presentation

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Title: Evaluating Mutual Fund Performance


1
Evaluating Mutual Fund Performance
  • Four important factors in analyzing fund
    performance
  • 1. Returns
  • 2. Investment Style and Risk
  • 3. Portfolio Composition
  • 4. Turnover and Taxes
  • Examining these factors reflects how a fund
    performed in the past. Past performance may not
    guarantee future performance.

2
Returns
  • Returns can be generated through
  • 1. Dividend Distributions
  • 2. Capital Gains Distributions
  • 3. ?NAV through unrealized Capital Gains
  • The importance of each component varies with the
    type of fund.
  • Growth, Capital Appreciation, Foreign funds -
    realized and unrealized Capital gains
  • Bond fund, Equity Income fund - Dividend and
    income

3
Returns
  • Returns can be generated through
  • 1. Dividend Distributions
  • 2. Capital Gains Distributions
  • 3. ?NAV through unrealized Capital Gains

4
Returns - Dividends
  • Dividends - also called investment income, has
    two sources
  • 1. Cash dividends paid stocks (quarterly)
  • 2. Interest payments made by bonds and other
    fixed income securities (Quarterly or semi-
    annually).
  • Fund distributes income according to its own
    distribution schedule (monthly, quarterly,.).
  • Elect to receive cash or reinvest in the fund
    at its NAV

5
Returns - Dividends
  • Undistributed dividends are placed in a money
    market fund (Cash like securities) until
    regularly scheduled payout date.
  • Ex-dividend Date On the day the fund
    distributes its income, NAV per share declines by
    the amount of cash payout. The date on which the
    NAV is reduced is called Ex-dividend date. Board
    sets the ex-dividend date.

6
Returns - Capital Gains
  • NAV can be affected by
  • 1. Realized Capital Gains
  • 2. Unrealized Capital Gains.
  • Realized Gains are any capital gains on
    securities that a manager has sold out of the
    funds portfolio.
  • Tax law permits capital gains to be distributed
    once a year. During the year, fund keeps track of
    realized capital gains and losses.
  • Net Capital Gains are distributed.
  • Elect to reinvest net capital gains, usually at
    POP.

7
Returns - Capital Gains
  • Unrealized Gains are funds paper profits. As
    market price of securities rises, the NAV per
    share also increases.
  • Any unrealized losses are also reflected on
    funds NAV.
  • Therefore, total return from a mutual fund for
    a given year is determined by the dividend
    distributions, net capital gains distributions,
    and ?NAV due to unrealized capital gains.

8
Total Return
  • Total return is computed for a given period of
    time, such as YTD, 1- year, 3-years, 5-years,
    10-years, etc., as mandated by SEC.
  • Total Return ENAV-BNAVDISTDIV BNAV
  • ENAV NAV at the end of period
  • BNAV NAV at the beginning of period
  • DIST capital gains distributions during the
    period
  • DIV dividend income during the period.

9
Total Return
  • Based on Washington Mutual Investors Funds NAV
    (Fig. 5.3)
  • Total Return 32.91-30.352.60.61
    19.01 30.35
  • Annualized Total Return
  • Average Annualized Total Return

10
Total Return
  • Discrepancy in computing Average Annualized
    Total Return
  • Fig. 5.3- 1996, 1997, 1998 returns are 20.16,
    33.29 and 19.37, respectively. Therefore,
  • Average Annualized Total Return
  • (20.16 33.2919.37)/3 24.28, but in Fig 5.1,
    3-year average is 22.9

11
Total Return and Cost
  • On-going expenses such as management fees,
    custodial fees, directors fees, 12b-1 fees) are
    deducted each day when fund computes NAV.
    Therefore, total return factors in on going
    expenses.
  • Sales load (back end or front end) and
    redemption fees are not factored in. Known as
    load-adjusted total return. It is less than total
    return. Not widely publicized.
  • SEC regulations mandate the formulas to be used
    as well as how the information must be presented.

12
Total Return and Cost
  • On-going expenses such as management fees,
    custodial fees, directors fees, 12b-1 fees) are
    deducted each day when fund computes NAV.
    Therefore, total return factors in on going
    expenses.
  • Sales load (back end or front end) and
    redemption fees are not factored in. Known as
    load-adjusted total return. It is less than total
    return. Not widely publicized.
  • SEC regulations mandate the formulas to be used
    as well as how the information must be presented.

13
Evaluating Total Return
  • Analyze Total Return by
  • 1. Reviewing the return over 3 or more years how
    it has performed during various bull and bear
    market cycles.
  • 2. Comparing returns with those of its peers over
    the same periods
  • 3. Comparing return to an appropriate benchmark.
  • Review Morningstar Mutual Fund Report
  • Review Value Line Mutual Fund Report

14
Investment Style and Risk
  • Large diversified fund protects investors
    against a decrease in the price of a single
    security.
  • Mutual funds do not protects their investors
    against market or systematic risk.
  • Risks associated with a mutual fund are
    determined by
  • 1. Funds investment objective
  • 2. Portfolio mangers investment style.

15
Investment Style and Risk
  • What is Investment Style?
  • On what basis does the manger choose the
    securities
  • How does the fund manager analyze the
    securities.
  • Three primary types of investment style
  • 1. Value
  • 2. Growth
  • 3. Momentum.

16
Investment Style - Value
  • Value Investing
  • Invest in companies whose current market value
    appears to be below the companys real worth
  • stock is below the value of comparable companies
    in the same business
  • Manger utilize fundamental analysis to assess
    value valuation techniques of the flowing type
    is often used
  • Price/ Earnings approach
  • Price/ Book Value approach
  • Dividend Growth approach

17
Investment Style - Growth
  • Growth Investing
  • Portfolio manager selects company based on
    expectation of strong growth
  • underlying belief is that if a companys
    earnings growth meets or exceeds analysts
    expectations, the stock price will appreciate.
  • Earnings announcements and price volatility
  • Stock price volatility is high during the period
    leading up to quarterly earnings announcements
  • This volatility reflects the price movement of a
    growth fund can be a Manger utilize fundamental
    analysis to assess value

18
Investment Style - Growth
  • Two earnings figures that determine the
    markets and managers reactions
  • 1. Earnings figure published by analysts. Usually
    more conservative number with build in
    contingencies surrounding the company and sector
  • 2. Whisper number. Amount analysts expect if all
    contingencies are realistically priced.
  • If the reported earnings exceeds expectations,
    price will increase, and vice versa.
  • If earnings growth is projected to slow down,
    price will fall.

19
Investment Style - Growth/Value
  • GARP - Growth at a Reasonable Price. A
    conservative approach that is a combination of
    growth and value styles.
  • Primary method is Price- to -Sales per share
    approach.
  • Fundamental valuation techniques may not be
    applicable for such companies.

20
Investment Style -Momentum Investing
  • Momentum Investing
  • Portfolio manager believes that the market value
    of the stock will increase rapidly
  • Ignores value measures when selecting stocks
    stocks may be overvalued or undervalued
  • As long as there are strong buy
    recommendations, sales and earnings continue to
    grow, exceeding expectations, stock price will
    continue to rise
  • Style resembles herd mentality.
  • This style is not in favor now.

21
Investment Style -Other Considerations
  • Other Considerations
  • Socially Responsible Investing
  • Green Funds - focuses on Environmental Issues
  • Fund may not invest in companies that exploits
    workers in foreign countries - case of South
    Africa.
  • Investing based on Insider trading
  • Follow the smart Money
  • Portfolio manager tracks the trading patter of
    senior executives and other insiders in the
    company
  • Their activities are reported to the SEC- public
    knowledge.

22
Other Risk Considerations
  • For Foreign and Global Funds
  • Currency Risk
  • Country Risk
  • For Bond Funds
  • Bond Quality
  • Interest Rate Risk

23
Turnover and Taxes
  • Turnover measures how often the total holding is
    changed.
  • 100 turnover - holding is changed once a year
  • 300 turnover - holding is changed three times a
    year
  • Low turnover is characteristic of a Buy-hold
    policy
  • Large Cap, Value investing, Bond fund etc.,
  • High turnover indicative of active trading
    strategy
  • Aggressive growth, Capital appreciation, momentum
    trading
  • High turnover creates higher transaction cost.
    Return must reflect this added cost.

24
Turnover and Taxes
  • High turnover is not always bad. Turnover should
    be judged against the objective of the fund.
  • Investors may equate high turnover with market
    savvy and intelligence of the fund manager.
  • When market performs well, investors ignore
    turnover and other cost associated with it. When
    market is flat or performing poorly, this cost
    stands out.

25
Turnover and Taxes
  • High turnover will result in higher realized
    capital gains (losses)
  • Capital gains must be distributed the year it is
    realized investors may be presented with a high
    tax liability
  • Distributed capital gains qualifies for short
    term or long term gains depending on the length
    of holding
  • A fund manager,with an eye toward tax
    efficiency, may minimize capital gains by
    lowering turnover.
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