The first place to find information on a mutual fund is in its prospectus. The Securities and Exchange Commission requires that the prospectus describe the fund’s investment objectives and policies in a concise “Statement of Investment Objectives” as well as in lengthy discussions of investment policies and risks. The fund’s investment adviser and its portfolio manager also are described. The prospectus also presents the costs associated with purchasing shares in the fund in a fee table. Sales charges such as front-end and back-end loads as well as annual operating expenses such as management fees and 12b-1 fees are detailed in the fee table.
Funds provide information about themselves in two other sources. The Statement of Additional Information, or SAI, also known as Part B of the prospectus, includes a list of the securities in the portfolio at the end of the fiscal year, audited financial statements, a list of the directors and officers of the fund as well as their personal investments in the fund, and data on brokerage commissions paid by the fund. Unlike the fund prospectus, however, investors do not receive the SAI unless they specifically request it; one industry joke is that SAI stands for “something always ignored.” The fund’s annual report also includes portfolio composition andfinancial statements, as well as a discussion of the factors that influenced fund performance over the last reporting period.
With more than 8,000 mutual funds to choose from, it can be difficult to find and select the fund that is best suited for a particular need. Several publications now offer “encyclopedias” of mutual fund information to help in the search process. One prominent source is Morningstar’s Mutual Fund Sourcebook. Morningstar’s website, www.morningstar.com , is another excellent source of information, as is Yahoo!’s site, finance.yahoo.com/funds . The Investment Company Institute the national association of mutual funds, closed-end funds, and unit investment trusts publishes an annual Directory of Mutual Funds that includes information on fees as well as phone numbers to contact funds. To illustrate the range of information available about funds, we consider a sample report from Morningstar, reproduced in Figure 4.5 .
Funds provide information about themselves in two other sources. The Statement of Additional Information, or SAI, also known as Part B of the prospectus, includes a list of the securities in the portfolio at the end of the fiscal year, audited financial statements, a list of the directors and officers of the fund as well as their personal investments in the fund, and data on brokerage commissions paid by the fund. Unlike the fund prospectus, however, investors do not receive the SAI unless they specifically request it; one industry joke is that SAI stands for “something always ignored.” The fund’s annual report also includes portfolio composition andfinancial statements, as well as a discussion of the factors that influenced fund performance over the last reporting period.
With more than 8,000 mutual funds to choose from, it can be difficult to find and select the fund that is best suited for a particular need. Several publications now offer “encyclopedias” of mutual fund information to help in the search process. One prominent source is Morningstar’s Mutual Fund Sourcebook. Morningstar’s website, www.morningstar.com , is another excellent source of information, as is Yahoo!’s site, finance.yahoo.com/funds . The Investment Company Institute the national association of mutual funds, closed-end funds, and unit investment trusts publishes an annual Directory of Mutual Funds that includes information on fees as well as phone numbers to contact funds. To illustrate the range of information available about funds, we consider a sample report from Morningstar, reproduced in Figure 4.5 .
Some of Morningstar’s analysis is qualitative. The top box on the left-hand side of the report reproduced in the figure provides a short description of fund strategy, in particular the types of securities in which the fund manager tends to invest. The bottom box on the left (“Morningstar’s Take”) is a more detailed discussion of the fund’s income strategy. The short statement of the fund’s investment policy is in the top right-hand corner: Laudus is a “large
growth” fund, meaning that it tends to invest in large firms, with an emphasis on growth over value stocks. The table on the left in the figure, labeled “Performance,” reports on the fund’s quarterly returns over the last few years and then over longer periods up to 15 years. Comparisons of returns to relevant indexes, in this case, the S&P 500 and the Russell 1000 indexes, are provided to serve as benchmarks in evaluating the performance of the fund. The values under these columns give the performance of the fund relative to the index. The returns reported for the fund are calculated net of expenses, 12b-1 fees, and any other fees automatically deducted from fund assets, but they do not account for any sales charges such as
front-end loads or back-end charges. Next appear the percentile ranks of the fund compared to all other funds with the same investment objective (see column headed “%Rank Cat”). A rank of 1 means the fund is a top performer. A rank of 80 would mean that it was beaten by 80% of funds in the comparison group. Finally, growth of $10,000 invested in the fund over various periods ranging from the past three months to the past 15 years is given in the last column.
More data on the performance of the fund are provided in the graph near the top of the figure. The line graph compares the growth of $10,000 invested in the fund and the S&P 500 over the last 10 years. Below the graph are boxes for each year that depict the relative performance of the fund for that year. The shaded area on the box shows the quartile in which the fund’s performance falls relative to other funds with the same objective. If the shaded band is at the top of the box, the firm was a top quartile performer in that period, and so on. The table below the bar charts presents historical data on characteristics of the fund such as return data and expense ratios.
The table on the right entitled “Portfolio Analysis” presents the 20 largest holdings of the portfolio, showing the price–earnings ratio and year-to-date return of each of those securities. Investors can thus get a quick look at the manager’s biggest bets. Below the portfolio analysis table is a box labeled “Current Investment Style.” In this box, Morningstar evaluates style along two dimensions: One dimension is the size of the firms held in the portfolio as measured by the market value of outstanding equity; the other dimension is a value/growth measure. Morningstar defines value stocks as those with low ratios of market price per share to various measures of value. It puts stocks on a growth-value continuum based on the ratios of stock price to the firm’s earnings, book value, sales, cash flow, and dividends. Value stocks are those with a low price relative to these measures of value. In contrast, growth stocks have high ratios, suggesting that investors in these firms must believe that the firm will experience rapid growth to justify the prices at which the stocks sell. The shaded box for Laudus shows that the portfolio tends to hold larger firms (top row) and growth stocks (right column). A year-by-year history of Laudus’s investment style is presented in thesequence of such boxes at the top of Figure 4.5 .
The center of the figure, labeled “Rating and Risk,” is one of the more complicated but interesting facets of Morningstar’s analysis. The column labeled “Load-Adj Return” rates a fund’s return compared to other funds with the same investment policy. Returns for periods ranging from 1 to 10 years are calculated with all loads and back-end fees applicable to that investment period subtracted from total income. The return is then compared to the average return for the comparison group of funds to obtain the Morningstar Return vs. Category. Similarly, risk measures compared to category are computed and reported in the next column. The last column presents Morningstar’s risk-adjusted rating, ranging from one to five stars. The rating is based on the fund’s return score minus risk score compared to other funds with similar investment styles. To allow funds to be compared to other funds with similar investment styles, Morningstar employs a large number of categories; there are now 48 separate stock and bond fund categories. Of course, we are accustomed to the disclaimer that “past performance is not a reliable measure of future results,” and this is true as well of the coveted Morningstar five-star rating.
The “Tax Analysis” box shown on the left in Figure 4.5 provides some evidence on the tax efficiency of the fund. The after-tax return, given in the first column, is computed based on the dividends paid to the portfolio as well as realized capital gains, assuming the investor is in the maximum federal tax bracket at the time of the distribution. State and local taxes are ignored. The tax efficiency of the fund is measured by the “Tax-Cost Ratio,” which is an estimate of the impact of taxes on the investor’s after-tax return. Morningstar ranks each fund compared to its category for both tax-adjusted return and tax-cost ratio. The bottom of the page in Figure 4.5 provides information on the expenses and loads associated with investments in the fund, as well as information on the fund’s investment adviser. Thus, Morningstar provides a considerable amount of the information you would need to decide among several competing funds.
front-end loads or back-end charges. Next appear the percentile ranks of the fund compared to all other funds with the same investment objective (see column headed “%Rank Cat”). A rank of 1 means the fund is a top performer. A rank of 80 would mean that it was beaten by 80% of funds in the comparison group. Finally, growth of $10,000 invested in the fund over various periods ranging from the past three months to the past 15 years is given in the last column.
More data on the performance of the fund are provided in the graph near the top of the figure. The line graph compares the growth of $10,000 invested in the fund and the S&P 500 over the last 10 years. Below the graph are boxes for each year that depict the relative performance of the fund for that year. The shaded area on the box shows the quartile in which the fund’s performance falls relative to other funds with the same objective. If the shaded band is at the top of the box, the firm was a top quartile performer in that period, and so on. The table below the bar charts presents historical data on characteristics of the fund such as return data and expense ratios.
The table on the right entitled “Portfolio Analysis” presents the 20 largest holdings of the portfolio, showing the price–earnings ratio and year-to-date return of each of those securities. Investors can thus get a quick look at the manager’s biggest bets. Below the portfolio analysis table is a box labeled “Current Investment Style.” In this box, Morningstar evaluates style along two dimensions: One dimension is the size of the firms held in the portfolio as measured by the market value of outstanding equity; the other dimension is a value/growth measure. Morningstar defines value stocks as those with low ratios of market price per share to various measures of value. It puts stocks on a growth-value continuum based on the ratios of stock price to the firm’s earnings, book value, sales, cash flow, and dividends. Value stocks are those with a low price relative to these measures of value. In contrast, growth stocks have high ratios, suggesting that investors in these firms must believe that the firm will experience rapid growth to justify the prices at which the stocks sell. The shaded box for Laudus shows that the portfolio tends to hold larger firms (top row) and growth stocks (right column). A year-by-year history of Laudus’s investment style is presented in thesequence of such boxes at the top of Figure 4.5 .
The center of the figure, labeled “Rating and Risk,” is one of the more complicated but interesting facets of Morningstar’s analysis. The column labeled “Load-Adj Return” rates a fund’s return compared to other funds with the same investment policy. Returns for periods ranging from 1 to 10 years are calculated with all loads and back-end fees applicable to that investment period subtracted from total income. The return is then compared to the average return for the comparison group of funds to obtain the Morningstar Return vs. Category. Similarly, risk measures compared to category are computed and reported in the next column. The last column presents Morningstar’s risk-adjusted rating, ranging from one to five stars. The rating is based on the fund’s return score minus risk score compared to other funds with similar investment styles. To allow funds to be compared to other funds with similar investment styles, Morningstar employs a large number of categories; there are now 48 separate stock and bond fund categories. Of course, we are accustomed to the disclaimer that “past performance is not a reliable measure of future results,” and this is true as well of the coveted Morningstar five-star rating.
The “Tax Analysis” box shown on the left in Figure 4.5 provides some evidence on the tax efficiency of the fund. The after-tax return, given in the first column, is computed based on the dividends paid to the portfolio as well as realized capital gains, assuming the investor is in the maximum federal tax bracket at the time of the distribution. State and local taxes are ignored. The tax efficiency of the fund is measured by the “Tax-Cost Ratio,” which is an estimate of the impact of taxes on the investor’s after-tax return. Morningstar ranks each fund compared to its category for both tax-adjusted return and tax-cost ratio. The bottom of the page in Figure 4.5 provides information on the expenses and loads associated with investments in the fund, as well as information on the fund’s investment adviser. Thus, Morningstar provides a considerable amount of the information you would need to decide among several competing funds.
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