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


One of the most important functions as an investment fiduciary is to monitor our entire investment lineup that we advise for our clients. It is almost like a report card for the advice we give. But not all performance-monitoring reports (PMR) are universal, and IFA’s take on the metrics that should be evaluated are much different than what other industry-leading practitioners provide.

Many practitioners take a Morningstar style approach to performance monitoring where expenses and past performance take the front seat in evaluation. Metrics such as expense ratio and past performance over the 1, 3, 5, and 10-year periods (if available) are common once investment choices have been grouped together by asset class. While this may seem extremely informative at face value, it doesn’t provide valuable insight into actions that need to be taken, if any. In other words, the report can be seen as basically meaningless. Here is why.

While expenses have played a crucial part in determining which funds are going to be superior performers over others,[1] past performance has been reliably unhelpful in determining future performance. Mark Carhart famously published his 1997 dissertation on the persistence of performance for mutual funds domiciled in the United States.[2] 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.[3]  In other words, it is hard to decipher whether the manager displayed actual skill or was just lucky. Either way, basing future investment decisions on past performance usually resulted in buying winners at their peak and selling losers at their trough (except for the very worst performing mutual funds as determined by the Morningstar study referenced above).

Although investors would be receiving a report that, at least for plan sponsors of qualified retirement plans, was part of a fiduciary process, it provided meaningless information. Well, it would maybe inspire that investor to abandon active management, but that is a topic for another conversation.

So if reporting on past performance provides nothing of value, what does? If you were to look at the Performance Monitoring Report that IFA provides, it can give 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.[4]

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 have written and quantified some of these costs before here. A common metric that captures some of these more obscure trading costs is “Turnover.” Although it is not robust, it does give 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 its portfolio’s holdings in 1 year. Compare that to a fund that has a turnover of 10%, which means that, on average, they are holding on to their positions for 10 years. The latter fund would, in general, have lower costs associated with trading, and when combined with a lower expense ratio, would be a better investment choice, all else equal.

We also look at metrics such as market capitalization and the Price-to-Book ratio since they provide 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. For example, if we were evaluating two different small-cap value funds 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. 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 2 funds that have identical expense ratios, P/B ratios, average market capitalizations, and turnover ratios, we would want to pick the fund that has the most holdings since it increases the likelihood of capturing the equity, size, and relative price premiums in the stock market. We also evaluate diversification by looking at the percentage of assets in the top 10 holdings.

Lastly, we include past performance, but not measured in terms of annualized performance. Rather, we give the 3, 5, and 10-year Sharpe Ratio for each fund since it more effectively captures performance in terms of risk taken. While traditional performance monitoring reports may not control for bad benchmarking, the Sharpe Ratio leaves the fund manager nowhere to hide. Ideally, we would like to have a factor that could capture size and relative-price factors, but these are not currently available. For now, the Sharpe Ratio will suffice. We also give very little weight to past performance since as we mentioned before, is a very poor indicator of future performance.

Within fixed income, we once again look at fees since they are 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 3, 5, 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] Kinnel, Russell. “How Expense Ratios and Star Ratings Predict Success.” Morningstar:

[2] Carhart, Mark. “On Persistence in Mutual Fund Performance.” Journal of Finance: March 1997.

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

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