Interpreting “Marketing” Returns From “Real” Investment Returns

I am often asked how to make sense out of the return data that is online. For instance, posts various return data. Some of their return data is adjusted for any front-end load that a fund charges. Morningstar’s return data typically is not adjusted for the annual fees that a fund charges. Fortunately, that adjustment just requires subtracting a fund’s annual fees from the fund’s reported annual return. Morningstar also reports a return that allows an investor to see a fund’s return after loads, taxes and other costs are factored in.

The way that funds report their performance also depends on whether the market is in a bull or bear phase. When times are good, funds will report their actual, or absolute, returns. When times are tough, funds will report their returns in terms of their performance relative to their peers, e.g. #1 rated fund in its class. Relative performance numbers are basically useless, as the fact that Fund X outperformed Fund Y can hide the fact that both funds experienced significant losses and significantly underperformed their relative benchmarks.

Investment performance analysis based on a fund’s incremental cost/benefit numbers is gaining acceptance among both the legal and investment industries. Investment industry legend Charles Ellis first introduced the concept of investment analysis using incremental costs and returns several decades ago in his seminal book, “Investment Policy,” now entitled “Winning the Loser’s Game.”

Using a fund’s incremental cost and return provides a more accurate representation of the value of a fund’s management team, as it relates a fund’s cost and return in comparison to the cost and return of a lower cost fund with comparable performance. Incremental investment analysis often reveals that an investor is paying annual fees that are 300% or higher than the low cost alternative, while receiving either no incremental return at all or an incremental return that is less than the added, or incremental, cost. In other words, to borrow from the band Dire Straits, an investor is paying “money for nothing.”

And this is not an isolated incident. Annual studies by Standard & Poors and Vanguard consistently show that the majority of actively managed domestic equity-based mutual funds fail to outperform comparable passively managed index funds. And yet, according to the 2015 Investment Company Institute Fact Book, 80 percent of the money invested in all domestic equity-based mutual funds is  invested in these over priced and underperforming actively managed mutual funds. Go figure! Further proof of the power of the informed investor.

Bottom line – Use the free metric, the Active Management Value Ratio 2.0™, to evaluate and select mutual funds that are efficient in terms of both cost and performance.

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