How to Analyze Mutual Fund Returns

Key Metrics for Evaluating Mutual Fund Returns

Total Return

• Definition: Total return includes the change in a fund's share price plus any dividends and capital gains distributions, assuming reinvestment.
• Example: Fidelity Contrafund (Nasdaq: FCNTX) reported a 16.23% total return from December 31, 2004, to December 31, 2005. This means a $10,000 investment grew to $11,623.

Compound Annual Return

• Definition: This is the average annual growth rate of an investment over a specified time period.
• Example: Over five years, Fidelity Contrafund had a compound annual return of 6.21%, growing a $10,000 investment to $13,515.34 by December 31, 2005.

Relative Return

• Definition: Compares a fund's performance to a benchmark or peer group.
• Example: Fidelity Contrafund outperformed the average large-cap growth fund by 14.69% and the S&P 500 by 5.67% over five years.

After-Tax Return

• Definition: The return on an investment after accounting for taxes.
• Example: Fidelity Contrafund's 5-year after-tax return was 6.10%, dropping to 5.33% after considering long-term capital gains taxes.

Risk-Adjusted Return

• Definition: Measures how much return a fund generates for each unit of risk taken, often using the Sharpe Ratio.
• Example: Fidelity Contrafund had a Sharpe Ratio of 1.74 over three years, indicating a strong risk-adjusted performance.

Different Perspectives on Mutual Fund Evaluation

Investor's Perspective

• Risk Tolerance: Investors should consider their risk tolerance when evaluating funds. A high Sharpe Ratio might appeal to risk-averse investors.
• Tax Considerations: After-tax returns are crucial for investors in high tax brackets.

Fund Manager's Perspective

• Performance Benchmarking: Fund managers often use relative returns to benchmark their performance against peers.
• Risk Management: Managers focus on maintaining a favorable risk-adjusted return to attract and retain investors.

Beyond Mutual Funds

These metrics are not exclusive to mutual funds. They can also be applied to:

• Separately Managed Accounts
• Hedge Funds
• Investment Newsletters

For example, the AlphaProfit Sector Investors’ Newsletter tracks both total and risk-adjusted returns for its model portfolios, aiming to maximize after-tax returns.

Summary

While total and compound annual returns provide a snapshot of performance, they don't tell the whole story. Metrics like relative return, after-tax return, and risk-adjusted return offer deeper insights into a fund's efficiency, tax implications, and risk management. Understanding these can help you make more informed investment decisions.

Notes

This article is for informational purposes only and should not be considered investment advice. Always consult a financial advisor for personalized guidance. For more information on mutual fund performance, visit Morningstar or Fidelity Investments.