Ashley Redmond: A fund's performance depends on various factors and when you're evaluating a fund's performance, you need to look at not only absolute returns, but how it's done compared to its peer group. Here to discuss this is Director of Fund Analysis in Canada, Christopher Davis.
Christopher, thanks for joining me.
Christopher Davis: Thanks for having me.
Redmond: So, what do we mean when we say relative performance?
Davis: Well, I have relatives and no pun intended, that come up to me all the time and say, I have a great mutual fund! It was up 10% for the year-to-date. That is absolute performance. I ask, well how does that fund compare versus its peer group or its benchmark? So, if their fund is up 10 but the market was up 20, did their fund really perform that well? You can definitely argue that it didn’t perform all that well because it only delivered half the markets return. So, that’s relative performance.
Redmond: So, as an investor, what performance numbers should they be looking at?
Davis: Well, the longer-term, the better. And so investors have this tendency to get fixated on one-year returns, year-to-date returns, even three-year returns, and they're pretty meaningless. A fund that performs well this year, may do poorly next year, but you want to focus on the longest time period. For example, you can look at 10-year returns. That’s really great especially for an equity fund. It is much more telling than a short time period.
Redmond: So, Christopher, what's the value in looking at a long-term performance number opposed to a short-term performance number?
Davis: Well, short-term performance has a lot of noise. You can perform well over a 1-, or a 3-year and even 5-year period simply out of luck or maybe you've taken a lot of risks and they've shown up in the fund performance. But over a 10-year period, it's a lot harder to be lucky. It’s possible, but you can’t – it's tough to win 10 years in a row based simply on luck.
Redmond: At Morningstar, we suggest doing an apples-to-apples comparison with benchmarks. Now what are some of the challenges with this comparison for investors?
Davis: Well, I think that one of the big challenges is identifying an appropriate benchmark. So, for example, if you’re investing in a Canadian equity fund, that's investing almost exclusively in Canadian stocks, then you can think of something like the S&P/TSX Composite as an appropriate benchmark. However, that wouldn't be the right benchmark if you were looking at Canadian small caps or if you were looking at international funds or a global fund. If you're investing in a global fund, maybe you would think of something like the MSCI World Index that reflects the entire world.
And so when you’re investing with the manager, you really want to reward them for their skill, and so if there’s a benchmark out there that you would be able to invest in through an index fund or an ETF much more cheaply than an active manager, then you want to at least invest with the manager that can beat the major benchmarks.
Redmond: So, the first step as an investor is definitely finding the appropriate benchmark and then applying the comparison?
Davis: That's right. And then think about what the fund’s strategy is. Does the fund’s performance match the strategy? So, for example, maybe the fund has lagged its benchmark in recent years, but if it’s a really conservative approach in the market and the market has been roaring, then maybe that’s exactly what you would expect. But over the long term, a fund should be able to outperform its peers or benchmark. But over the short term? Not necessarily.
Redmond: Thanks, Christopher.
Davis: Thanks for having me.
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