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Importance of Performance (Unit Trust)

18 May
Performance data is valuable to chart the progress of your investment. While performance is a key evaluator in identifying a suitable fund, it is not the only factor upon which you should base your decision. It is important to understand that unit trusts do not offer a fixed rate of return: your principal value will fluctuate, and the return on your investment is not guaranteed. The rates of return fluctuate with market conditions, changes of the valuation of the securities a fund invests in, or other factors. For that reason, it is helpful to examine performance over various time periods.
 
Historical Results
It is important to keep in mind that performance is based on historical results and is not intended to project future performance of a fund. Ensure that the fund’s objectives as well as the manager’s investment style and strategy are aligned with yours. While yesterday’s data is no guarantee of future performance, the long-term track record is a useful barometer of the manager’s skill and expertise in managing different market cycles.

When comparing funds, it is best to focus on long-term performance because financial markets (and the economy) tend to go through cycles that can last for several years. For instance, small-company stocks (and funds) will at times outperform large-company stocks (and funds). At other times, the large-company stocks/funds will be the star performers. A common mistake investors make is to constantly “chase” the best-performing funds from the recent past. Unfortunately, last year’s “hot” sector of the financial market may be replaced this year by a different sector.

As historical data is never perfect, the additional information paves the way for investors to make more informed investment decisions. They should also remember that a top or winning fund may not necessarily be the most suitable fund for them.

If you are comparing the performance of several funds, be sure that you are making accurate comparisons: compare fund with the same investment objectives and fund policies before looking at the numbers.

The value of investment may fall as well as rise and investors may/may not get back the amount originally invested. Changes in the currency exchange rates may cause the value of the investment to increase or diminish if you are investing in an offshore fund.

 
Measuring Fund Performance
A unit trust fund’s performance can be measured by its total return. A fund’s total return is the change in the value of an investment in the fund, taking into account any change in the fund’s unit price during the period and assuming the reinvestment of income and capital gains distributions.

Total return is commonly presented in two ways. One is called the fund’s cumulative total return, or total rise in the value of a fund’s investments over time, assuming that income and capital gains distributions were reinvested. The other is called average annual total return, which is the compounded total return, it would take each year to produce the fund’s cumulative total return. Seemingly modest annual returns can be converted, through the power of compounding, into impressive cumulative returns. For example, an average annual total return of 7% would, after ten years, amount to a cumulative total return of 97%.

When evaluating fund performance, a good approach is to compare its total return with the returns of similar funds or with the return of an appropriate market index or benchmark over the same time period. A stock fund should be compared with other similar stock funds – ones that invest in the same type of companies. A bond fund should be compared with bond funds that invest in bonds of similar maturities and credit quality (rating). You can usually find the name of the appropriate market index or benchmark on a fund’s prospectus or manager’s (annual and semi-annual) report

 
Information Ratio
Absolute or total return tells the investor how much the distribution-adjusted net asset value of a fund has changed over a specific period. It only addresses the funds return for a certain period against its peers, without considering its risk.

In contrast, the information ratio is a reward-to-volatility (risk) ratio. It is calculated based on the fund’s returns earned in excess of a benchmark such as its peer group average, taking into consideration the fund’s risk as measured by the standard deviation in its relative returns over measurement period. The information ratio tells the investor how much better a fund performed in comparison with its peers from the reward/risk point of view.

The information ratio is one of the most important tools used to measure the performance of a fund’s portfolio management. It is a straightforward way to evaluate the relative returns that the fund managers achieve, given the relative risk they take on, against a benchmark. All investors, no matter what their aversion to risk is, will obviously seek the highest information ratio possible. The higher the ratio, the more consistent and greater the fund return.

 
Example:
Assume:
i) Three-year time period; 
ii) Fund A monthly average returns = 15%; and
iii) Fund B monthly average returns = 12%.
Many investors who do not know risk analysis would say that the better performing fund would be Fund A with its 15 per cent returns. However, when you go through a risk-adjusted analysis using the data such as the information ratio (see tables below), investors will see a different picture:
 
TABLE A : Risk-adjusted analysis of Funds A1 and B1 (Scenario 1)
Funds Monthly Avg. Return Average ReturnExcess Excess Return Std. Dev. Information Ratio
A1 15% -0.06 0.06 -1
B1 12% -0.05 0.06 0.83
 
TABLE B : Risk-adjusted analysis of Funds A2 and B2 (Scenario 2)
Funds Monthly Avg. Return Average ReturnExcess Excess Return Std. Dev. Information Ratio
A2 15% -0.06 0.06 -1
B2 12% -0.06 0.08 -0.75
 
In the scenarios above, Fund B would be considered to have performed better than Fund A in terms of rewards versus volatility relative to their peer group performance. This is because the information ratio for Fund B is higher, although Fund A recorded higher absolute returns.

A rather complicated mathematical formula is used to calculate the information ratio, so unless you have a financial calculator, you may want to simply refer to published unit trust fund performance rankings.

 
Unit Trust Fund Performance Rankings
Unit trust fund rankings, ratings or other evaluations of fund performance can provide an important way for you to compare your fund’s past performance with other funds. Unfortunately, investors often interpret these rankings as recommendations, or even as projections for future performance, which they clearly are not.

Your best protection is being an informed investor. Request prospectus from the funds you are considering and read them carefully to understand their goals, risk factors, performance record and procedures for buying and selling shares.

Professional ranking services, financial magazines and investment newsletters are the most common sources for this information, but there are others — and not all present the same information or use the same criteria for evaluating funds. As an investor, you should be aware of how these reports differ and how this information can be used by you in making sound investment choices.

Rankings or ratings provide another piece of important information that can be used in the selection of fund investments, but they should not be used as the only basis for your decisions. You still need to do your homework on the funds you are considering. Identify your goals and evaluate a fund’s ability to meet your goals within your investment timeframe and at the level of risk you are able to accept.

All performance rankings and ratings show how a fund has performed in the past and is no guarantee that it will continue to do so. Rankings are a good barometer, however, for determining if a fund has been well-managed over the years, or if it has consistently performed in a particular manner.

~ Source: http://www.fimm.com.my ~

 
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Posted by on May 18, 2012 in UNIT TRUST

 

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