Mutual Fund Return Analysis with Fidelity Contrafund Example
|Investment Newsletters||Best Fidelity Funds||Best ETFs||Get Free Reports||10-Year Journey||Blog|
Mutual Fund Basics: Analyzing Mutual Fund Returns
While total and compound annual returns are useful in analyzing mutual fund returns, discerning investors will delve deeper using a variety of metrics to get a more complete picture on mutual fund performance.
On December 16, 2005 a leading financial website reports the trailing 1-year and 5-year returns of Fidelity Contrafund (Nasdaq: FCNTX), a no-load mutual fund, as 19.01% and 6.97%, respectively. While the financial website provides useful pre-tax return information, there is more to mutual fund returns.
Is the performance of Fidelity Contrafund superior or inferior?
How tax-efficient was Fidelity Contrafund in delivering these returns?
Are the returns of Fidelity Contrafund commensurate with the risk its fund manager took?
Discerning mutual fund investors will want answers to such questions as they evaluate mutual fund returns. Before getting into the nitty-gritty of mutual fund returns, it is good to review what the data reported in the financial website actually mean.
Fidelity Contrafund's reported 19.01% 1-year return is this mutual fund's total return for the December 16, 2004 to December 15, 2005 period. In practical terms, $10,000 invested in Fidelity Contrafund on December 16, 2004, is worth $11,901 on December 15, 2005. Total return includes more than the appreciation (or depreciation) of the mutual fund's share price. It also assumes reinvestment of all dividends as well as short- and long-term capital gain distributions into the mutual fund at the price at which the distribution is made.
The reported 5-year return of 6.97% for the Fidelity Contrafund is the mutual fund's compound annual return. (The compound annual return is also called average annual return.) Compound annual return is a calculated number that describes the rate at which an investment has grown if it grew at a steady rate.
A $10,000 investment in Fidelity Contrafund on December 16, 2000 has grown to $14,005.87 on December 15, 2005. The ending value of $14,005.87=$10,000* [(1+0.0697)^5] where 6.97% is the compound annual return. The investment in Fidelity Contrafund grew at an implied growth rate of 6.97% over the 5-year period.
While total return and compound annual return are useful mutual fund performance metrics, they do not tell how a particular mutual fund has fared versus its peers. They also do not provide information on the return actually earned by investors after accounting for taxes. Finally, they do not offer insight on how well the mutual fund manager has managed risk while achieving the returns.
Relative return helps in comparing the performance of a mutual fund against its peers. Relative return is the difference between the total return of a mutual fund and the total return of an appropriate benchmark over the same period.
Fidelity Contrafund is a large-cap growth mutual fund that primarily invests in U. S.-based companies. It is therefore appropriate to compare Fidelity Contra's performance with that of other large-cap growth mutual funds. It is also appropriate to benchmark Fidelity Contra against indexes like the Standard & Poor's 500 (S&P 500) which comprises of large U. S.-based companies.
While Fidelity Contrafund has a compound annual return of 6.97% for the 5-year period ending December 15, 2005, Morningstar reports the average large-cap growth mutual fund to have an average annual loss of 9.51%. The S&P 500 index has a compound annual return of just 0.61%. Fidelity Contrafund has outperformed both benchmarks with a relative return of 16.48% over its average large-cap growth mutual fund peer and a relative return of 6.36% over the S&P 500 index.
Unlike return from assets held in qualified accounts such as 401k plans or individual retirement accounts, return from assets held in non-qualified individual or joint accounts are not tax-deferred. With non-qualified accounts, after-tax return is the return realized after accounting for taxes.
"While total return and compound annual return are useful mutual fund performance metrics, they do not tell how a particular mutual fund has fared versus its peers. They also do not provide information on the return actually earned by investors after accounting for taxes. Finally, they do not offer insight on how well the mutual fund manager has managed risk while achieving the returns."
Short-term capital gains and short-term capital gain distributions received from the mutual fund are currently taxed at the same rate as earned income. Dividends, long-term capital gain distributions, and long-term capital gains realized from the sale of mutual fund shares are currently taxed at a lower rate.
Fidelity states the compound annual return for the Fidelity Contrafund before taxes is 4.01% for the trailing 5-year period ending September 30, 2005. When all distributions are taxed at the maximum possible federal tax rate, the after-tax return drops to 3.52%. The after-tax return drops further to 3.23% after accounting for the long-term capital gain tax due on sale of this mutual fund's shares.
Some mutual funds take more risk than others. It is therefore important to evaluate mutual fund returns in the light of the amount of risk mutual fund managers take to deliver the return.
Risk-adjusted return is commonly measured using the Sharpe Ratio. It is calculated using the formula (mutual fund return - risk free return)/standard deviation of mutual fund return. The higher the Sharpe Ratio, the better the fund's return per unit-risk.
Based on returns for the 3-year period ending November 30, 2005, Morningstar reports Fidelity Contrafund's Sharpe Ratio as 1.74. Fidelity Contrafund's Sharpe Ratio may be compared with those of similar mutual funds to determine how Fidelity Contra's risk-adjusted return compares with those of its peers.
Return concepts such as relative return, after-tax return, and risk-adjusted return are useful in analyzing not only mutual funds but also separately-managed accounts, hedge funds, and investment newsletter model portfolios.
The AlphaProfit Sector Investors' Newsletter, for example, tracks the annual return and compound annual return of its Core and Focus model portfolios. To provide Subscribers with more complete picture on model portfolio returns, this investment newsletter also tracks the relative and risk-adjusted returns of the model portfolios. The investment newsletter's model portfolios are constructed and repositioned with a view to maximizing after-tax returns.
While total return and compound annual return provide useful information on mutual fund performance, they do not provide a complete picture. Metrics such as relative return and after-tax return can provide valuable insights on a mutual fund's relative performance and tax efficiency. By looking at risk-adjusted returns, investors can assess how a mutual fund's returns stack up when risk is factored in.
Rollover IRA: 401k Retirement Plans' Booster Rocket, Rollover IRA
Best No Load Mutual Funds: Looking at Mutual Fund Fees and Expenses the Right Way
Mutual Funds: What Investors Need to Know About Morningstar Fiduciary Grades
FREE SIGN UP!
Protect & grow your wealth with
By Hulbert #1 rank winner Dr. Sam Subramanian
'Incisive Insights, Impressive Results' - Jim Woodruff
We respect your privacy. We will not spam or sell your information to others, period.
Popular How-To Guides
Recent MoneyMatters Articles
About AlphaProfit MoneyMatters and AlphaProfit
AlphaProfit MoneyMatters is a free e-letter distributed to registered users of AlphaProfit's website. The e-letter analyzes the economy, markets, and sectors and provides money-making insights on stocks, exchange-traded funds, and mutual funds. AlphaProfit MoneyMatters is edited by Dr. Sam Subramanian acclaimed for his financial acumen and analytical skills.
AlphaProfit Investments, LLC is an independent investment research firm based in Sugar Land, TX. AlphaProfit publishes the AlphaProfit Sector Investor's Newsletter, edited by Dr. Sam Subramanian. Leveraging sector funds, the Newsletter provides high-performance model portfolios with Fidelity funds and exchange-traded funds. It also includes actionable stock recommendations. This newsletter features among MarketWatch's top 10 investment newsletters and has won the coveted #1 rank from Hulbert Financial several times.
Copyright Policy and Fair Use Guide
You are welcome to quote a short excerpt of the article not exceeding 100 words with attribution in the form of a hyperlink to the article's full URL or http://www.alphaprofit.com. If you wish to republish the article in full on your website, blog, or other media, you must obtain permission.
AlphaProfit MoneyMatters™ is for information purposes only. Nothing herein should be construed as an offer to buy or sell securities or to give individual advice on investing. Factual material is obtained from sources believed to be reliable and is provided without warranties of any kind. AlphaProfit Investments, LLC is not responsible for any errors or omissions. AlphaProfit Investments, LLC neither is associated with nor receives any compensation from any of the investment companies, brokers or entities connected with the securities mentioned herein. Please review our Terms and Conditions of Use and Subscriber Agreement which is available on our website at www.alphaprofit.com; they govern your relationship with AlphaProfit Investments, LLC, including, but not by way of limitation, use of the AlphaProfit MoneyMatters.
This page is best viewed in 1024 by 768 pixels screen resolution or higher.
Copyright © 2005 AlphaProfit Investments, LLC. All rights reserved.