Is it all about performance on mutual funds?

November 23, 2018

My experience over 30-some years in the financial-services business tells me that most people start with performance (that is, past performance) when choosing an investment — or a money manager.

Are investors relying too much on past performance? Should they be provided additional information to help them understand the risks and potential rewards of the investment or investment service?

These types of questions are currently being considered by the U.S. Securities and Exchange Commission in connection with mutual funds. To help improve disclosure, the SEC asked mutual fund investors for feedback on how performance information enters into the investment decision (SEC Release No. 33-10503: “Request for Comment on Fund Retail Investor Experience and Disclosure”).

By the way, it’s not too late to send in your comments, even though we’re beyond the published cutoff date, and it might be a good exercise. Here is the link to the release: https://www.sec.gov/rules/other/2018/33-10503.pdf.

I’ll follow up when the SEC publishes its findings, but in the meantime, it’s helpful to review what the regulators want to know.

Here is a sample:

“[D]o you use [performance] to evaluate the risk of a fund, or do you use it for some other purpose, such as to assess the skill of the investment manager?

“How could funds improve the presentation of performance information?

“Should past performance information be emphasized or de-emphasized in fund disclosures?

“Should short-term performance periods (such as 1-year) be de-emphasized and longer-term performance periods be emphasized?”

These all are important questions to consider. Most important is the first: The SEC is really asking what the performance numbers tell you — how do they guide you in making a buy, sell or hold decision.

The main thing is that investors need context. That is, historical performance is good information and useful for comparing and contrasting similar investments. But it doesn’t mean that you will replicate the results after you make a purchase. There is a lot more involved. You’ll want to know what the manager is attempting to accomplish (that’s in the prospectus). You’ll also want to look at history to judge whether the manager has met his or her objectives. That you’ll find in the fund’s annual report. You’ll also want to compare the manager to peers, which the SEC is considering making a mandatory disclosure as well. However, at this point, to do a peer analysis, you need to do some of your own legwork using databases such as Steele Systems and Morningstar.

Getting back to the annual report, in the Management’s Discussion of Fund Performance (MDFP), you’ll find the factors that materially affected the fund’s performance, including market conditions and strategies.

The MDFP includes 10-year performance graphs comparing the fund with an appropriate index, such as the S&P 500, and a table with the fund’s average annual returns for the most recent one-, five- and 10-year periods.

The SEC believes the MDFP can help “investors understand fund performance, the strategies the fund has used, and the risks it has taken on. This can help investors make decisions about whether to buy, sell, or continue to hold fund shares.” If the regulators have this point of view, it’s probably a good idea to read the full annual report. Self-directed investors would need to read it thoroughly, along with the prospectus, of course. Keep in mind that the prospectus tells you the fund’s plan; the annual tells you how it executed the plan.

If you have a point of view on how the SEC’s mutual fund disclosure documents can be improved, you can comment here: https://www.sec.gov/cgi-bin/ruling- comments. Again, even though it’s a few weeks beyond the cutoff for the comment period, it’s not too late to state your views. I suppose the most important thing to get across is what information you need in order to make an informed decision.

To engage in a dialogue about performance through this column, email me at readers@juliejason.com. Please put “performance” in the subject line and where you read the column.

A final note: I’m thinking of establishing an award for employees who fully appreciate the benefits of their company’s 401(k) plan. Let me know if you think that’s a good idea by emailing me at readers@juliejason.com.

Julie Jason, JD, LLM, a personal money manager (Jackson, Grant of Stamford, Conn.) and author, welcomes your questions/comments (readers@juliejason.com). Her awards include the 2018 Clarion Award, symbolizing excellence in clear, concise communications. Her latest book, a curated collection of Julie’s columns, is “Retire Securely: Insights on Money Management From an Award-Winning Financial Columnist.” To hear Julie speak, visit www.juliejason.com/events.

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