Investor Alert: Improving Your Shareholder Literacy

By Lynn M. Mckeel, Fall 2017 IAC Student Intern

Now that you have invested in mutual funds, you should expect two important documents to arrive in the mail. The first is a semi-annual report expressing the first 6 months of the fiscal year. The second is an end of year report, documenting the returns for the entire fiscal year. These reports are created by the mutual fund and are sent to the SEC before distribution to the fund holders. It is important to remember these reports are not created by the SEC, rather they are created by the mutual fund. It helps to think of these reports as “report cards” on the fund’s progress and returns.

If you have never reviewed a mutual fund shareholder report, take a few minutes to review the SEC Investor Bulletin entitled How to Read a Mutual Fund Shareholder Report. The SEC has numerous explanations for interpreting the reports, as well as resources for spotting red flags in your report.

The SEC’s Bulletin explains a few key sections of these reports. So long as the funds include the required information listed in the tables below. Funds may use their discretion including any additional information. The SEC requires the funds to disclose the tabled topics. Does your annual report contain all of the topics listed below?





Below we have broken down the most important aspects of the report. While you review your report, remind yourself why you purchased these particular funds. Did the geographical location of the holdings interest you? Were you inclined to invest in a particular industry? Were you looking for a reliable account, consistent with market trends or were you willing to take risks contrary to historical performance? Remember your preferences while you review the shareholder reports.

This Investor Alert does not contain all of the sections contained in the shareholder report, however it will provide a basic understanding of the holding’s performance.

Management’s Discussion

One of the first sections of the report is known as the Management’s Discussion. This is an opportunity for the fund’s management to discuss various factors contributing to the fund’s progress. Most reports will specify which holdings exhibited the strongest and weakest returns and whether there were any specific contributing factors.

Line Graph

Reports will include a line graph comparing the performance during the last 10 years of a “hypothetical $10,000 initial investment”. Two lines are included on the graph, the first, a line representing the progress of a value of hypothetical $10,000 investment and, the second, the progress of a hypothetical $10,000 broad-based securities market index, such as the S&P 500. Do the lines follow a similar path or do they diverge and crisscross dramatically? Do the lines look like a smooth, consistent line or a ragged mountain range? If the history is choppy with deep peaks and valleys, the fund has experienced variations in performance and had a volatile history.

These lines will help you determine if your investments are following the general flow of the market, exceeding market returns, or more dipping while the rest of the market flourishes. While you review, consider the level of risk you intended to take with these investments.

Performance Table

The performance table shows the fund’s average annual return for 1, 5, and 10 years. The SEC recommends focusing on the 5 and 10 year returns. The SEC warns against funds that perform strongly over the last year but poorly over the past 5 or 10 years. The SEC warns “past performance is not necessarily an indication of future results.

Expense Example

One of the more complicated aspects of the report will be the Expense Example. The SEC states, “the expense example is calculated using a fund’s expense ratio for the preceding six months but does not include the impact of the sales loads, if any.” The first table is the actual cost in dollars for a $1,000 investment over a six-month period. The SEC Bulletin provides excellent examples of how these expenses are calculated and we recommend consulting the bulletin while reviewing your reports. The second table makes it possible to compare the expenses of the fund with that of other funds, allowing you to review your operating funds against those of a completely different fund. Do you funds have consistent operating expenses with that of the example funds?

Financial Statements

The financial statement section provides a summary of the top 50 portfolio holdings. This section is important in discerning what assets the fund actually holds. This is where the investor can view a complete painting of the assets and their performance. The SEC recommends considering the following questions while reviewing the financial statements:

  • Are the fund’s holdings, as reflected in the financial statements, consistent with the fund’s investment objectives and strategy as stated in the fund’s prospectus?
  • Are the fund’s holdings consistent with your expectations, based on the fund’s name, investment objections, strategy, and principal risks as disclosed in the fund’s prospectus?
  • Do you detect any “style drift,” meaning the fund has strayed from its stated investment objectives (for example, an international stock fund that is unusually concentrated in domestic stocks, or a specific country fund that holds a lot of assets in a country other than the one identified in the name of the fund)?
  • Do the fund’s holdings overlap or mirror those of other funds that you own? If so, your investments may not be sufficiently diversified. Unless you intend to concentrate your investments in a few stocks or bonds or industry sectors, consider adjusting your asset allocation to achieve a more diversified portfolio.

Why are these questions important? For poorly performing holdings, or holdings which you suspect were purchased under negligent or bad faith conditions, these holdings will shed light on the actual investments. For example, in extreme situations, you may have been told you were investing in gas energy however the financial statements may show investment spread among multiple industries. Similarly, you may have been told your assets were held in local sectors of the economy, but the financial statements may show investments spread amongst international holdings across the world. Compare the financial statements against the conversations you’ve held with your broker to confirm the funds contain holdings reflecting your intended investments.

Graphical Representation of Holdings

An interesting and simple way to understand the real world application of your investments in seen in the Industry Sector Graph. This graph provides an easy to digest understanding of the allocation of investments. For example, the graph will show information such as the percentage of holdings in the health care sector, energy sector, industrial sector, telecommunication sector, etc. Take time to compare this graphical explanation against what is seen in the financial statements. Any disparities should be noted and discussed with your broker.

The more you review your shareholder reports, the more comfortable you will become at interpreting and digesting their information. The shareholder reports are complicated and not meant for light reading, so please take a few minutes to review the links below. Once you become comfortable with the language and intention of the reports, you will have a much easier time reviewing these vital documents.

For further information please refer to the following resources:

SEC Investor Bulletin: How to Read a Mutual Fund Shareholder Report

Mutual Funds: A Guide for Investors

Mutual Fund Investing: Look at More than a Fund’s Past Performance