Even if you are not a heavy trader nor give a lot of attention to the stock market, most individuals eventually have to answer the question, “Which mutual fund should I invest in?”. This is mainly due to the millions of dollars that flood into company retirement plans where the only available investment options are either exchange-traded funds or mutual funds. For that reason, I thought it would be helpful to go over a quick Morningstar report on a mutual fund and point out some key figures that should be looked at prior to electing your investment options.

Morningstar reports are normally provided by your company’s retirement plan during your investment election period and give you a brief overview of the mutual fund’s goals, current asset allocation, and performance history. These reports allow investors to get a quick glimpse into the potential fund they might be investing in as well as see an insight in how the manager is currently investing the funds. And even if it’s not a Morningstar Report, the information we will go over below is normally provided by whichever mutual fund analysis reports that your company chooses to use. Now, these reports are not going to help you decide how to allocate your funds to the different asset allocations (stocks versus bonds, large cap stock versus small cap stock, etc) but will rather help you compare two similar funds that might be in the same category (ie – large cap stocks). We will go over some ideas on asset allocations in later lessons. But for now, let’s take a look at the below Morningstar report for American Funds Growth Fund of America – ticker AGTHX.

   American Funds Growth Fund of America (AGTHX) is one of the largest mutual funds that invest in US stocks and has been around since the 1970’s. Doing a quick search on the internet, you can find that the investment objective of AGTHX is as follows:

“The investment seeks growth of capital. The fund invests primarily in common stocks and seeks to invest in companies that appear to offer superior opportunities for growth of capital. It may invest a portion of its assets in securities of issuers domiciled outside the United States. The investment adviser uses a system of multiple portfolio counselors in managing the funds assets. Under this approach, the portfolio of the fund is divided into segments managed by individual counselors who decide how their respective segments will be invested.”

Basically…this is a mutual fund whose main goal is to invest in large-cap stocks with the objective of growing the assets via capital appreciation of the stocks. So this would be a key holding in a retirement plan and can be compared to 100’s of available mutual funds with the similar large-cap growth investment objective. Pretty simple.

So let’s take a look at the Morningstar report. There are four main categories of information that should be looked at when analyzing a mutual: the overview of the mutual fund, the current holdings/allocation of the fund, the historical performance, and then the associated fees. Let’s just go one at a time.

Mutual Fund Overview :   The main things you should first look at for a fund are the investment objective/category, the asset size of the fund, the inception date of the fund, and the manager name/tenure. The investment category is what you’ll use to determine which funds to compare to one another. For AGTHX, you can see the Morningstar put it in the category of US Large Cap Growth…makes sense. So, if your retirement fund provider has multiple investment options within the category of US Large Cap Growth, then compare them side-by-side. But the Category/Investment Objective is a good way to make sure you are comparing apples-to-apples.

The asset size and inception date is a good way to see how established a fund is. Obviously, the larger funds tend to have a successful track record and have developed their market analysis and trading skills over time. That’s not to say that a small fund is necessarily an unsuccessful one…especially a new fund. But a mutual fund with significant assets didn’t get there through poor investment decisions and lacking performance numbers. The same theory goes with older inception dates.

For our fund, the inception date of 11/30/1973 is a positive queue as well as the $120.582 billion in assets that the fund has. Definitely not a small number.

The final thing that you might want to look at is the manager name. Although our fund does not list a specific manager, most funds have a key player that calls all of the shots and decisions for the fund. Bill Gross is an example of one of these players as he runs one of the biggest mutual funds available – Pimco Total Return Bond Fund (PTTAX). It’s good to get a name behind a fund and possible even do a internet search for his name to view his biography. If you’re looking for a mutual fund that invests 100% of it’s assets in the health care industry, then you’ll obviously want a manager who has a background in the health care industry or has extensive research history for the industry.

Current Holdings/Allocation :

The highlighted area above is the section that you should look at for the current holdings/allocation of the mutual fund. For some investors, this area is irrelevant as they personally do not have an opinion on the current market environment. But if you are a bullish investor and want to invest in a mutual fund that will grow with the market, then you definitely do not want to invest in a fund that currently has 20-30% in cash sitting on the sideline. Or if you’re bearish on the energy sector, you definitely don’t want to invest in a fund that is significantly overweight in energy. So you want to make sure the fund you choose matches with your current views on the market.

Now, even if you don’t have an opinion on the market, there are still a few things you can look at. First, take a look at the top holdings on the fund. Although the names might not mean anything, look at the percent weighting of the top holdings. A key figure that we normally like to look at is the top ten holdings’ percent weighting. For our fund, we’ll add up the top ten holdings “% Net Assets” to see that the top ten holdings make up approximately 23.5% of the portfolio. This is a healthy weighting. What you don’t want to see is that the top ten holdings make up 70-100% of the fund. Such heavy weightings can make for a very volatile mutual fund. Plus, you’re investing into a mutual fund in order to diversify your money…not concentrate it within 10 names. So it’s always good to make sure that the top 10 holdings are at healthy weightings.

Same theory goes with the total number of holdings in the fund. For our fund, you can see that there are 269 total stocks within the fund, further proving the diversification inside of the fund.

Most of the other information will only be helpful for investors who currently have an opinion on either sectors, holdings, or even countries. But remember…you are investing in these mutual funds because you want a professional money manager to invest your money. So don’t feel like you need to stay on top of the economy news, the market changes, and analyst predictions in order to make sure that your mutual fund is aligned with your research. Instead, just focus your time and attention in the money manager and the overall fund portfolio structure and then trust that they can handle the rest. That’s why you’re “hiring” them in the first place.

Historical Performance : The most common thing that 95% of investors look at is the past performance of a mutual fund. Although it is extremely important to look at, you need to know that it is not the only thing that should be looked at. The most common disclaimer you will find on almost every mutual fund report you read is the phrase “Past performance is no indication of future results”. In fact, you can see the disclaimer on this Morningstar report in the upper left which reads “The performance data quoted represents past performance and does not guarantee future results”. However, past performance is definitely something that should be looked at.

The upper middle section of the report is pretty easy to read. This breaks down the performance of the fund on a yearly basis, comparing the figures with the “standard index” and the “category index”. This is a great way to see how the money manager did through various investment periods. My favorite to look at are 2008 and 2009. Everybody is familiar with 2008, one of the biggest down years in recent history. So take a look at the 2008 calendar year to see how the manager reacted/performed through a large down market. Did he/she raise his cash level? Did he/she sell some of the stocks? For 2008, the S&P 500 was down an even 37.00%. So with our example mutual fund down 39.07%, it fell short of index. However, this is a large cap growth index so we should compare it to an index that solely tracks growth stocks. Morningstar’s “category index” takes care of this, using the Russell 1000 Growth index as a comparative benchmark. You can see that ABTHX fund barely missed that benchmark by 0.63%. A little better.

But now let’s look at the 2009 year. This was a great recovery year with the S&P 500 index up

26.5%. So this is great to see how the money manager performed in a recovery stage. Did he find the stocks that were way undervalue after the 2008 “crash”? You can see that ABTHX was up 34.48% in 2009very impressive. However, the Category Index (the Russell 1000 Growth index) did outperform ABTHX by 2.73%. Still impressive though.

A year-by-year analysis is useful…but you’re in this for the long run. So definitely take a look at the long-term track record…especially the 5, 7, and 10-yr track record. I’ve highlighted where to find this on the Morningstar report below:

So take a look at the 5-year and 10-year figures of 3.73% and 8.31%. These are annualized performance figures. That means that if you invested in this fund for the past 10 years, the average rate of return you would have received every year would have been 8.31%. That’s extremely impressive and beats both the S&P 10 year average annual return (7.58%) and the Russell 1000 Growth index average annual return (7.75%). So again, it’s a great way to compare the track records on two or more different mutual funds that fall into the same investment category.

But don’t just look at the return of the fund. Take a look at the standard deviation of the fund as well. The standard deviation represents the volatility of a fund. So the higher the standard deviation is, the more “ups-and-downs” that you can expect to experience. For a quick calculation, take the average annual return for the past 10 years and add/subtract the standard deviation from this figure. You can expect that any given year’s performance will fall inside of this range. For our example, the 10 year standard deviation for ABTHX was 14.94. So, this mean that for any given year we can expect the return of the fund to fall into the following range:

8.31%  ±  14.94%  =  -6.63% to 23.25%

So any given year, we can expect a down year of -6.63% or a possible up year of 23.25%. Just remember, in general, the higher the standard deviation, the larger the ups-and-down of the fund and, in return, the more risky it can be.

Fees. One of the most overlooked item of a mutual fund are the associated fees to that fund. Many times, when two mutual funds are equal in performance and are allocated similarly, then I normally turn to the Gross Expense Ratio to determine which is the cheapest mutual fund to hold. Although the fee tells you nothing about the manager, the fund, and the historical performance, it’s still useful information that needs to be considered.

For our fund, the Morningstar report shows the below figures:

Now…the front-end load is specific to the A-share of this fund. So this would be 0% if you were buying a C-share or i-share, etc (see the lesson on Mutual Fund Share classes to brush up on this topic). The main thing you want to look at is the Gross Expense Ratio. This is the % of mutual fund assets that are taken out every year to cover management fees, advertising fees (12b1 fees), and all other expenses associated with running the fun. So, with a 0.71% Gross Expense Ratio for ABTHX, we can expect them to take our 0.71% of the fund every year for fee purposes. So, if the fund grows by 10% one year gross of fees, then the actual return that we will see as investors is 9.22%   (1 + 10%) / (1 + 0.71%).

Remember…if you are going to compare expense ratios of two different mutual funds, you need to make sure that you are comparing the same share-classes. Comparing a A-share mutual fund to a C-share mutual fund will give you an incorrect analysis since the A-share’s annual expense will be significantly lower than the C-share due to the large up-front fee. So be sure to compare A-shares with A-shares, C-shares with C-shares, etc.

So now you are hopefully a little more confident in picking the mutual funds to invest in. And remember…your company is going to choose strong mutual funds to put as investment options for your 401k and/or company retirement account. So do not feel too stressed in picking the “wrong” fund as most of the analysis was already done by your company. But still look at the things we discussed above…especially when investing outside of your 401k as there will be thousands of different mutual funds to choose from.

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