Mutual Fund Companies want you to invest in their funds. They can be extremely persuasive in luring you in with visually appealing ads of happy families, retired couples and the like indulging in the well-earned fruits of their investment fortunes. Golf courses of verdant green, steam wafting dreamily out of a luxurious mineral hot spring – they certainly know how to push our buttons. But it will be a far better use of time for the goals-oriented investor to brush past the imagery and get right to the true performance data.

Here are five ways to read between the lines when you are evaluating the data:

#1: What are the data sources?

It may sound simple, but it is not always easy to ascertain that the data given comes from independent, objective sources. You may read something along the lines of this: “A recent survey by Peerless Analytics confirmed that the BlastOff Fund was first in its peer group for the last twelve months”. Make sure you find something in the disclosure section that identifies the corporate identity of Peerless Analytics and whether there is any material relationship between that organization and the BlastOff Fund. This kind of problem is more likely to surface with funds owned and operated by large mutual fund companies with diversified (and often conflicting) business interests.

#2: Are the returns GIPS-compliant?

It is not the prettiest of acronyms, but GIPS is a term with which every investor should be familiar. It stands for Global Investment Performance Standards and is a trademark of the CFA Institute. These performance standards are widely accepted as the industry gold standard for fair, objective reporting of investment performance. There is no need for you to know the pros and cons of arithmetic versus geometric means, or the relative merits of time-weighted returns and IRR – if a fund can demonstrate that its presentation is GIPS-compliant, then you can feel confident that you are looking at credible numbers. This information should be in the disclosure statements that support the data (you should be getting the idea by now that reading the disclosure statements is really important, even if you need to buy a more powerful pair of reading glasses to deal with the miniscule font size).

#3: Are returns shown for multiple time periods?

One trick that some funds like to use is to present a performance snapshot with what would appear to be a rather arbitrary set of dates as endpoints. Is there any reason why the period reported for BlastOff Fund starts on April 21 of one year and ends on May 17 of the next? Two reasons only: either the fund’s inception date was April 21, and May 17 was the last trading day before the ad went to press (in which case, it is probably legitimate), or that particular 389-day period happened to coincide with an unusually good performance (in which, case it is bogus). A good performance presentation will include results from inception to date, and average annual returns for all applicable time periods from 10, 5, 3 and 1 year to date. The best way to look at past performance data is to analyze it over multiple time periods to see how consistent performance has been in different market conditions.

#4: Does the information include appropriate risk metrics?

At Jemstep, we never tire of emphasizing how important the risk side of the equation is when taking returns performance into account. Ideally, the presentation should include both a measure of absolute risk, such as standard deviation, and a measure of relative risk (relative, that is, to whatever performance benchmark the fund uses, like the S&P 500 or the Barclays Government/Credit Bond index). Beta is typically the most widely used measure of relative risk. Remember that the higher the volatility, as expressed by the risk metric, the greater the chance of waking up one morning to a stomach-churning plunge in your portfolio’s value.

#5: Was the same management team in place throughout the performance period?

When you look at numbers over different points in time, it is important to know who was making the decisions at each of those time points. If today’s management team started working at the fund twelve months ago, then whatever results were generated three or five years ago may not be particularly relevant. That is not necessarily the case – a fund may employ a highly disciplined quantitative strategy that owes more to computer algorithms than to human decisions. But it is necessary to dig into the details and find out. In addition to performance period distortions, management team turnover may be a sign of organizational or other problems at the fund or its parent company – another good data point in the evaluation process.

Learning to read performance presentations beyond the headlines and the catchy visual images can help investors minimize the likelihood of making ill-informed investment decisions.

When used intelligently, performance evaluation can be a useful (though not conclusive) data point, but should not be used in isolation. In a later post, we will talk about the cautions you should take in relying on past performance data to assess a fund’s future prospects.

Tell Us: Do you think fund performance presentation materials are misleading?

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