1. 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. 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. 3 Returns Returns can be generated through: 1. Dividend Distributions 2. Capital Gains Distributions 3.  NAV through unrealized Capital Gains

4. 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. 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. 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 fund’s 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. 7 Returns - Capital Gains Unrealized Gains are fund’s paper profits. As market price of securities rises, the NAV per share also increases. Any unrealized losses are also reflected on fund’s 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. 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-BNAV+DIST+DIV 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. 9 Total Return Based on Washington Mutual Investors Fund’s NAV (Fig. 5.3): Total Return = $32.91-$30.35+$2.6+$0.61 = 19.01% $30.35 Annualized Total Return Average Annualized Total Return

10. 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+ 33.29+19.37)/3 = 24.28%, but in Fig 5.1, 3-year average is 22.9%

11. 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. 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. 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. 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. Fund’s investment objective; 2. Portfolio manger’s investment style.

15. 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. 16 Investment Style - Value Value Investing – Invest in companies whose current market value appears to be below the company’s 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. 17 Investment Style - Growth Growth Investing – Portfolio manager selects company based on expectation of strong growth; – underlying belief is that if a company’s 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. 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. 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. 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. 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. 22 Other Risk Considerations For Foreign and Global Funds: – Currency Risk – Country Risk For Bond Funds – Bond Quality – Interest Rate Risk

23. 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. 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. 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.