How to Track Mutual Fund Performance: Benchmarks, Ratios & Metrics

A fund's headline return is only the start. To judge whether a fund is doing its job, you need to know what to compare it with, what it costs, how bumpy the ride has been and how much of its result came from skill rather than from simply taking more market risk. This guide explains each of those checks in plain language, with worked examples you can reproduce in the Mutual Fund Return Calculator.

The same kind of product has different names. In the US and Canada it's a mutual fund. In the UK it's usually a unit trust or an OEIC (open-ended investment company). In Australia it's a managed fund. In each case, money from many investors is pooled and invested by a professional manager, and everything below applies to all of them.

What to compare a fund against

A return means little on its own. For example, 8% in a year when similar investments made 15% is weak, while 8% in a year when they lost money is strong. Two comparisons matter most:

• Your fund's stated benchmark. This is the index the fund names in its prospectus as the market it invests in. Morningstar, a fund research firm, notes that a fund which moves closely with its stated index has probably chosen a suitable one, while a weak link can mean the index doesn't represent the fund's style well.
• Its peer group. These are funds that invest in similar things. Fund research firms sort funds into categories so you can compare like with like.

Look at long periods rather than last year alone. Australia's regulator, ASIC, says on its Moneysmart site that performance over 5 to 10 years gives a better idea of how well a fund has done the job it was designed to do, and to be cautious of a fund that hasn't kept pace with its benchmark or peers over the long term, even if last year's return was strong.

Total return, not just the price

A fund can make money for you in three ways: income it pays out as distributions, capital gains it distributes, and a rise in the value of its units or shares, the net asset value (NAV). Watching only the price leaves out the distributions. Total return counts the price change and the distributions together.

Example: a fund's unit price goes from $20.00 to $21.00 over a year, and it pays $0.60 per unit in distributions. The price rose 5%, but the total return was 8%: (21.00 − 20.00 + 0.60) ÷ 20.00. Comparing the 5% price change with an index's total return would make the fund look worse than it was.

Fees: the cost you can see in advance

Every fund has ongoing costs, taken from the fund's assets, so you pay them indirectly. They're deducted before a fund's returns are calculated and published, so published returns are already after these costs. The headline figure goes by different names:

Some funds also charge entry, exit or performance fees on top. As the SEC's Investor.gov puts it, even small differences in fees can mean large differences in returns over time, and a fund with high costs must perform better than a low-cost fund to give you the same result.

Example: you invest $10,000 for 20 years in two funds that both earn 6% a year before fees. One charges 0.20% a year and the other 1.00%, and to keep the arithmetic simple, the fee comes straight off each year's return. The cheaper fund grows to $30,882.56 and the dearer one to $26,532.98: about $4,350, or 14%, less for a fee gap of 0.8% a year.

Risk: how bumpy was the ride?

Volatility

Standard deviation measures how widely a fund's returns have varied around their average. A higher figure means a wider spread of results, in other words more volatility. Morningstar works it out from monthly returns and then scales it to a yearly figure. Investor.gov notes that past performance can show how volatile or stable a fund has been, and that the more volatile a fund is, the higher the investment risk.

Drawdown

A drawdown is a fall from a previous high. The largest one shows what holding the fund through its worst stretch would have felt like. Example: a fund's unit price rises from 100 to 120, then falls to 90. That's a 25% drawdown from the peak, and the fund then needs a 33.33% gain just to get back to 120.

The Sharpe ratio: return for the risk taken

The Sharpe ratio, developed by the economist William Sharpe, measures reward per unit of risk. In its simple form:

Sharpe ratio = (fund return − risk-free rate) ÷ standard deviation

The risk-free rate is the return on an investment treated as having no risk, so the top line is the extra return the fund earned for taking risk. A higher ratio means better risk-adjusted performance in the past. Morningstar calculates it from monthly figures, using the standard deviation of that extra return, but the idea is the same.

Example: both funds are measured over the same period with the same 4% risk-free rate.

Fund A earned more, but Fund B earned more for each unit of volatility. Keep the limits in mind: the ratio describes the past, standard deviation counts sharp rises as well as sharp falls as "risk", and the comparison only works when both funds use the same period and the same risk-free rate.

Beta and alpha

Beta measures how sensitive a fund has been to movements in its index. The index itself has a beta of 1.00. In Morningstar's description, a fund with a beta of 1.10 has tended to do 10% better than the index in rising markets and 10% worse in falling ones. Example: with a beta of 1.2, if the index's return above the risk-free rate is +10%, the fund's would be about +12%, and about −12% if the index's is −10%. A low beta doesn't mean low volatility, though: a fund that holds mostly gold can swing a lot and still have a low beta, because it doesn't follow the stock market.

R-squared shows how closely a fund's movements line up with its index, from 0 to 100%. A high R-squared makes the beta figure more reliable.

Alpha is the return a fund earned above what its beta would predict. It stops a manager getting credit for beating the market simply by taking more market risk.

Example: the risk-free rate is 4%, the benchmark returns 9% and the fund returns 10% with a beta of 1.2. The fund beat its benchmark by 1 percentage point. But the benchmark's return above the risk-free rate was 5%, so with a beta of 1.2 the fund was expected to earn 1.2 × 5% = 6% above the risk-free rate, and that's exactly what it earned (10% − 4%). Its alpha is 0: the extra return came from extra market risk, not from the manager's skill.

Alpha has limits. Morningstar points out that it's only as useful as the beta it relies on, and that a negative alpha can simply reflect fund expenses that the index doesn't have. Its alpha and beta figures normally use the last 36 months of returns, which is a short window.

Past performance doesn't predict the future

Regulators make the same point in every market. Investor.gov says past performance does not predict future returns, and Moneysmart says past returns are not a reliable guide to future returns. Use the figures above to understand how a fund behaved and what it cost, not as a forecast of what it will earn next.

Where to find a fund's figures

• US: the expense ratio is in the fee table of the fund's prospectus.
• Canada: fees are set out in the fund's Fund Facts document and its simplified prospectus, which fund companies must file with the securities regulator.
• UK: under the FCA's current disclosure rules, the ongoing costs figure appears in the fund's product summary.
• Australia: most of what you need is in the fund's Product Disclosure Statement (PDS).

Ratios such as standard deviation, Sharpe, alpha and beta are published by fund research firms. Their method notes, two of which are listed in the sources below, explain the period and the index each figure uses, so check those before comparing two funds.

A short checklist

1. Compare total return with your fund's stated benchmark and a peer group over 5 to 10 years.
2. Check the ongoing cost (expense ratio, MER, ongoing costs figure or management fees and costs) and any entry, exit or performance fees.
3. Look at volatility and the worst drawdown, and ask whether you could have sat through it.
4. Compare Sharpe ratios only over the same period and with the same risk-free rate.
5. Read alpha together with beta and R-squared.
6. Treat all of it as history, not a forecast.

To work out your own fund's return from what you paid in and what it's worth now, use the Mutual Fund Return Calculator.

The examples in this article use invented numbers to show how the measures work. They are illustrations, not predictions or financial advice.