Is your mutual fund a star or a dog?

Question

Each month I contribute into a mutual fund that was sold to me by a friend’s financial adviser years ago. Is there a simple way to tell if this fund is any good?

Answer

The Lipper Awards are to the mutual fund industry what the Oscars are to Hollywood: Prestigious and career-building to be sure, but perhaps lacking bold face names on the red carpet. Still if the mutual fund you own happens to have won one of these fancy statuettes—in either the three-, five- or 10 year category—I would say that your fund is pretty good.

However, as with movies, there are a lot of great mutual fund managers out there who won’t ever earn the privilege of thanking their moms in front of thousands of bored, slightly inebriated colleagues in a hotel ballroom. So how can you tell if your fund is first-class without spending days evaluating every detail on performance, risk, volatility, and fees?

There is one very rudimentary test you can perform and it will take you less than five minutes. What you have to do is check to see how has your fund been performing versus its benchmark index over time.

Sound simple? It is.

A simple check on mutual fund performance

Trying to determine if a fund you own is a star or a dog is a little different than trying to pick a fund from the thousands on offer. The simplest way to rate mutual fund performance is to compare it to its “benchmark index” over time. Say you own a large cap Canadian equity mutual fund. You would compare its performance against the TSX 60, an index that focuses on large cap Canadian stocks.

It is important to look at performance over time—say five to 10 years. A fund manager can have two great years and eight crumby ones so it is best to look at how he or she has done over the long haul.

Mutual fund data is easy to find

There are a number of sources for the information you need—Globefund.com and Morningstar.ca are perhaps the best known. Canadian Business also has a Mutual Fund Lookup tool. Grab your mutual fund statement then visit one of these websites and type in the name of your fund into the search box. You’ll be able to find a table that shows the performance over different time horizons similar to the one below.

The first column identifies the fund’s performance while the second column tracks the average performance for the group of funds that are similar in style. The final column shows the performance of the benchmark index, in this case the S&P/TSX Total Return.

Scan down to the 10-year line in the example below—we’ll call it the XYZ Canadian dividend fund. In the case of this mutual fund you can see it returned an average 4.79% per year, over the last 10 years. That might seem okay until you compare it to the benchmark index, which was up 9.79% per year on average. To put it another way, a $10,000 investment in this fund would have grown $15,138 over that 10-year period whereas that same investment in the index would have grown to $23,597 over that same period. That is an enormous difference.

Mutual Fund Performance

	FUND	GROUP AVG.	INDEX*
1 month	2.04%	2.30%	3.43%
3 months	3.75%	3.98%	7.02%
6 months	0.89%	-1.08%	0.95%
1 year	9.82%	9.77%	9.17%
2 year avg	3.42%	1.39%	2.61%
3 year avg	3.14%	2.84%	5.52%
4 year avg	0.24%	1.92%	4.25%
5 year avg	-3.85%	-2.49%	0.22%
10 year avg	4.79%	5.98%	9.83%
15 year avg	3.92%	4.46%	6.06%
20 year avg	6.72%	7.54%	9.18%

*S&P/TSX Total Return

Not quite apples to apples

Comparing your mutual fund to the benchmark index isn’t a perfectly fair comparison. While you can buy an index through an index fund or an exchange-traded fund, doing so comes with a cost, which will drag down your overall return.

But fees aside, what these charts really tell you is whether your mutual fund is in the game or not. You’d like it to be beating the index, of course, but more importantly it tells you whether your fund is even competing at the same level over time as its index or peer group. The mutual fund I used in the example above is definitely not in the game. It is a dud, a turkey, or in Hollywood parlance, a flop. I certainly wouldn’t want to base my retirement dream on it.

Past performance doesn’t predict the future

The other thing to know is that this table highlights past performance and cannot predict the future. The fund companies very carefully point this out in their marketing materials, but it isn’t just a disclaimer. You really need to understand this for yourself. Fund managers can lose their touch. Or they can leave the company and be replaced by someone who never had the touch in the first place.

So while past performance doesn’t predict the future, to the positive or to the negative, if can provide a simple check as to whether your fund is any good. Is it Avatar? Or Ishtar? Take five minutes right now and see what the numbers say about your fund.

And one final point, if you’ve been investing in the same fund regularly over the past 10 years then your investment is likely getting pretty substantial. Remember to rebalance your portfolio periodically to smooth out your return and protect your nest egg. Also, check out my post on knowing when to draw the line on your relationship with your financial adviser. It will help you determine if you’re getting your money’s worth on the financial advice you’re paying for.