IFA's Take On What's Appropriate for a Performance Monitoring Report


One of the most important functions of a wealth management fiduciary -- i.e., a firm requiring its advisors to put a client's interests first, not their own -- is to monitor the entire investment lineup used to manage each person's portfolio of stocks and bonds.

At IFA, results of such a review process are broken down and analyzed almost like a report card. But not every firm does this type of Performance Monitoring Report (PMR). In fact, our take on the metrics that should be evaluated -- as well as how to report back to clients what's really going on in their portfolios -- can vary a great deal from how it's done by other industry leading practitioners. 

From our discussions with independent analysts, record-keepers and other industry professionals, we've found that many investment management firms take a Morningstar-style approach to performance monitoring. In these types of reports, expenses and past performance take front seat in the evaluation process. Metrics such as expense ratio and past performance over one-, three-, five- and 10-year rolling periods (if available) are common once investment choices have been grouped together by asset class.

At face value, this might seem extremely informative. In the view of IFA's investment committee, however, it doesn't always provide as valuable of insight into actions that need to be taken (if any) for most investors. Our advisors are concerned that too frequently this type of reporting procedure and analysis can fall short, rendering such findings as basically meaningless. 

While a host of Morningstar studies point out that expenses have played a crucial part in determining which funds are going to be superior performers over others, no guarantees exist for extrapolating past performance as a determinant of future performance.

Mark Carhart famously published his 1997 dissertation on the persistence of performance for mutual funds domiciled in the United States.1 Professors Eugene Fama and Ken French followed up on Carhart's work and showed that the distribution of active managers that beat their benchmark over time is almost identical to a distribution based on random chance.2

In other words, it's hard to decipher whether the manager displayed actual skill or was just lucky. Either way, such studies show us that basing future investment decisions on past performance can usually be expected to lead to buying winners at peak levels and selling losers in troughs. 

PMR reports based on such a limited set of data might (at least for plan sponsors of qualified retirement plans) seemingly fit in terms of meeting basic fiduciary standards. But in our investment committee's view, such a report would provide almost meaningless information for clients interested in really digging into key characteristics of how different funds are (or aren't) working together in a globally diversified and long-term oriented portfolio.

Well, such a PMR could possibly inspire investors to abandon active management, but that's a topic for another time. 

In any case, if reporting on past performance provides nothing of value, what does? The Performance Monitoring Report that IFA provides aims to give investors some insight into what actually matters when vetting different mutual funds. Key items are based off of the tenants of modern portfolio theory and the known dimensions of expected returns.3

Expenses are in fact very important when evaluating mutual funds. While the expense ratio provides the "hard" costs associated with mutual funds, it doesn't give a full representation of the costs involved in investing in mutual funds. Absent the load and 12b-1 fees, which IFA would never recommend, there are implicit trading costs that can erode the overall performance of a fund when it is excessive.

(We've quantified some of these costs in our Deeper Look series evaluating major fund families. You can find these articles by using's search tool and typing in "Deeper Look" to find out more about our overall fund evaluation process. Please also feel free to explore our Selecting Investments series detailing how IFA's portfolio management and research team evaluates appropriate passively managed funds for client portfolios. Links to these articles can be found here and here as well as here.)

A common metric that captures some of the more obscure trading costs our process considers relate to "Turnover." Although not especially robust, this metric does give us a good idea about which funds are experiencing higher costs associated with trading. For example, a fund that has an annual turnover of 100% is basically changing over its portfolio's holdings in one year. Compare that to a fund that has a turnover of 10%, which means that on average it's holding on to positions for 10 years.

The latter fund, in general, would have lower costs associated with trading, and when combined with a lower expense ratio, would be a better investment choice -- all else being equal.

We also look at metrics such as market capitalization and the price-to-book ratio. This is because such measures provide us with a description of the overall size and style of a mutual fund, which as we know, are two factors that drive long-term performance in equities.

If we were evaluating two different small-cap value funds, for instance, and one had a smaller average market capitalization and lower price-to-book ratio, we would see an overall greater benefit investing in that fund (all else equal), since we know these are known risk-factors that we expect to be compensated for with higher returns.

Diversification is a key element in financial risk management and we believe it to be essential. As a result, we also report the number of holdings for each fund as to highlight the amount of diversification within a particular fund. For example, if we compare two funds -- with identical expense ratios, P/B ratios, average market capitalizations and turnover ratios -- we'd want to pick the fund that has the most holdings. This is due to the fact that a more diversified portfolio statistically increases the likelihood of capturing the equity, size and relative price premiums in the stock market.

It's also important to check overall holdings with those making up an index fund's largest constituents. Therefore, as part of our PMR process, we also evaluate fund diversification by looking at the percentage of assets in its top 10 holdings.

Lastly, we include past performance -- just not measured in terms of annualized performance. Rather, we give the three-, five- and 10-year Sharpe Ratio for each fund since it more effectively captures performance in terms of risk taken. And while traditional performance monitoring reports may not control for bad benchmarking, we do study factors that could capture size and relative-price factors. Again, we also give very little weight to past performance since as we mentioned before, it's a very poor indicator of future performance.

Within fixed-income, we once again look at fees since they're probably even more important within the bond fund universe. We also provide the average effective duration for each bond fund. As we know, average effective duration captures the term premium, which is the greatest significant explanatory factor in the cross-section of bond returns. We also provide the three-, five- and 10-year annualized standard deviation as to capture any other variation in bond returns -- such as credit quality or the shifting along the yield curve.

Providing a performance monitoring report is necessary when acting as a fiduciary for investors. There are significant pitfalls in traditional reporting methods as they focus too much on past performance, which gives little insight and provides not immediate action items. We have decided to create our own PMR based on metrics that we think are important for investors to know such as the dimensions of expected return for stocks and bonds, diversification, expenses as well as trading costs.

For more information about our Performance Monitoring Report and our scoring methodology, you can access our most recent PMR here.


[1] Carhart, Mark. "On Persistence in Mutual Fund Performance." Journal of Finance: March 1997.

[2] Fama, Eugene & Ken French. "Luck versus Skill in the Cross-Section of Mutual Fund Returns." Journal of Finance, 65 (October 2010), 1915-1947.

[3] Fama, Eugene & Ken French. "The Cross-Section of Expected Returns." Journal of Finance, 47 (June 1992), 427-465.

This is not to be construed as an offer, solicitation, recommendation, or endorsement of any particular security, product or service. There is no guarantee investment strategies will be successful. Investing involves risks, including possible loss of principal. Performance may contain both live and back-tested data. Data is provided for illustrative purposes only, it does not represent actual performance of any client portfolio or account and it should not be interpreted as an indication of such performance. IFA Index Portfolios are recommended based on time horizon and risk tolerance. Take the IFA Risk Capacity Survey ( to determine which portfolio captures the right mix of stock and bond funds best suited to you. For more information about Index Fund Advisors, Inc, please review our brochure at or visit