What Fund Fact Sheets Never Tell You?

Fact sheets are must-read materials for every mutual fund investor. Fund’s performance, benchmark index performance.....

YT Kum, CFA 26.06.2007
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Fact sheets are must-read materials for every mutual fund investor. Fund’s performance, benchmark index performance, net asset value, total fund size, top 10 holdings, manager’s comments…all these can be seen from fact sheet. However, a wise investor needs to know more, even that kinds of information never appear on fact sheets.

Fund inflow?Fund outflow?
Fact sheets never tell you whether there is net capital inflow or outflow last month. However, some investors regard fund flows as an important barometer of the popularity of funds, since hot funds can entice more new investors'capitals.

Growth of fund size can be attributed to two major sources: 1.) Fund return, and 2.) Cash inflows. Therefo

re, investors can roughly evaluate the cash flows by comparing the funds'monthly return with the growth of the fund size. The relationships are as follows:

Return < Growth of fund sizeNet fund outflow
Return > Growth of fund size Net fund inflow
Generally speaking, fund managements do not welcome cash redemptions, because it would add difficulties to portfolio management (of course, also reducing income from management fee). Continuous capital outflows compel fund management to sell some holdings to free cash, which would interrupt their planned trading strategies, and hence hurt the fund’s performance.

However, it is worth noting that fund flow itself is not a buy/sell signal but a mere reference. The investment style and performance data should remain at the top priority of investors'consideration.

Meanings behind printed texts
Linguistics is not only the ABC of philosophy, but also a threshold of mutual fund investment. Investors should never presume that they share same understanding with fund management companies on the subject investment. It is better for investors to ask more questions regarding the definition of key terms on fact sheets.

Some Hong Kong equity funds outline their investment objectives as "to provide investors with long-term capital appreciation through investment in equity securities of HKSAR companies". What does "equity securities of HKSAR" truly mean?

Investors may think they know the answer if they do not further read the top ten holding lists of those funds, which may contain H-shares or red chips like China Life, China Mobile or China Mengniu Dairy. In fact, fund managements may interpret the term "equity securities of HKSAR" as "equity listed on Hong Kong Stock Exchange" or "companies with significant business interests in Hong Kong" at their discretions. Fact sheets, however, may not provide enough details on this regard.

Any small discrepancy in understandings of key terms may cause a huge difference in the risk level of investors'portfolio. For instance, if an investor plans to invest in a Hong Kong equity fund to help diversify his fund portfolio containing a China equity fund, any Hong Kong equity funds, which define "Hong Kong equity" as "equity listed on Hong Kong Stock Exchange", may not help. (In fact, as Hong Kong economy is now tied closely to China economy, diversification benefits of Hong Kong equity funds, in this case, might be limited).

With the same logic, investors can raise a lot of questions concerning how fund managements define large/mid/small cap, particular sectors and the word "others" in asset composition breakdowns. Again, investors should never assume every word appeared on fact sheets is precise, and hence more information sources are needed, like prospectus or Morningstar websites, which provide investors with independent holding-based analyses on funds'investment styles.

Is the benchmark really a benchmark?
Fact sheets often tell you the funds'benchmark indices. However, investors need to evaluate the effectiveness of fund benchmark. A fund’s benchmark acts as references for both fund’s performance and investment style. However, the underlying assumption is that the composition of the benchmark is comparable to the fund’s portfolio; hence their comparison is apple-to-apple.

With no doubt, the portfolio of an actively managed fund should be different from the benchmark; otherwise, they are index funds of exchange traded funds (ETFs) by nature. Investors should justify the degree of comparability between the fund and its benchmark. If funds deviate greatly on size and value/growth, their benchmarks are less representative. In other words, even though the fund claims that they have well outperformed the benchmarks over years, investors should not solely depend on that slice of information.

Some global fixed income funds choose 6-month Treasury bill, which is default risk free by nature, as their benchmark indexes, but their portfolios hold mainly corporate bonds, which are not default risk free. As the risk type and level are different, the benchmark can no longer tell investors anything concerning fund’s investment styles or act as a good reference for its performance.

Benchmark index is set at management’s discretion and investors should not solely rely on it to evaluate a fund’s performance. Another useful comparison would be its peers in the same Morningstar category.

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About Author

YT Kum, CFA  YT Kum is a consultant for Morningstar, contributing to manager selection and asset allocation activities in Asia, and is responsible for providing investment thought leadership on topics relevent to investors in Asia.  

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