Ten Things a Fund Prospectus Won’t Tell You; A lot of crucial information isn’t there. Here’s what’s missing—and how to get it

Ten Things a Fund Prospectus Won’t Tell You

A lot of crucial information isn’t there. Here’s what’s missing—and how to get it.


Nov. 3, 2013 4:00 p.m. ET

So, you’re trying to decide whether to buy a mutual fund or ETF, and you need to know the essential facts. Here’s an unfortunate truth: You won’t find many of the answers you need in the prospectus. Whether you have the svelte “summary” version or the less commonly distributed “statutory” prospectus, which can run to dozens of pages, a lot of the information necessary to make an informed decision just isn’t there. Here are 10 key questions that aren’t answered by the prospectus, and instructions on how to easily find this must-have information:1. Is this fund costly compared with other choices?

The prospectus details a fund’s expenses using a standardized methodology from the Securities and Exchange Commission, but it offers no context. For an actively managed fund, look at the average for the fund’s Morningstar Inc. MORN -0.67%category. For example, look up a diversified emerging-markets stock fund on Morningstar.com, go to the “Expense” tab, and you’ll see an average expense ratio of 1.64%.

David Grecsek, director of investment strategy and research for financial adviser Aspiriant, says he compares a fund’s expense ratio with those of competing funds and also checks “how much it would cost us to replicate market exposure passively” with an index mutual fund or exchange-traded fund. Among emerging-markets ETFs, for example, Vanguard FTSE Emerging Markets ETF VWO -0.05%charges 0.18%.

2. How has this fund performed relative to competitors?

Prospectuses show performance relative to one or more market indexes, but generally not to peers. On Morningstar.com and on WSJ.com (which uses data from Thomson ReutersCorp.’s TRI.T +1.35% Lipper unit) you can see how a fund has performed vs. peers over periods such as the past one, three and five years, as well as year by year. (The fund and markets data on WSJ.com is available to nonsubscribers as well as subscribers.)

David Snowball, publisher of the Mutual Fund Observer website, looks for funds that have been average to above average year after year—but he doesn’t avoid stock funds that are laggards in periods when the market is frothy and the manager is playing it safe.

3. What’s the fund’s actual asset mix?

While prospectuses describe what a fund may invest in, look to the fund’s website for what the fund actually held recently. Many list the top 10 holdings and provide pie charts that show the sectors or countries a manager has been favoring. For an index fund or ETF, that breakdown shows the areas that dominate the benchmark. That information may be part of a monthly or quarterly fact sheet on the website.


On Morningstar.com, the “Portfolio” tab for a stock fund shows how a fund’s sector and world-region exposure compares with a benchmark and peers. Note that a fund with an idiosyncratic portfolio might do a lot better—or a lot worse—than the benchmark and peers.

4. How concentrated is that stock portfolio?

The average U.S.-stock mutual fund (excluding sector funds) recently had around one-third of its assets in its top 10 holdings, according to Morningstar, but some funds have more than 80% or even 90%. You can typically find the figure—or add up the largest holdings yourself—on a fund’s website.

“We think it’s a good thing to concentrate—or it can be in the hands of the right person,” says Doug Muenzenmay, a financial adviser with Medley & Brown LLC in Jackson, Miss. But because a concentrated fund will usually be more volatile, he generally doesn’t want to see a figure over 50%.

Concentration is an issue for many single-country index funds, because a few huge companies may dominate a market. Numerous single-country ETFs in the iShares lineup employ a capping methodology to limit concentration but still have more than 50% of assets in their top 10 holdings.

5. For a bond fund, what is the average duration and credit quality?

While the prospectus will spell out the parameters for picking bonds, look to the fund’s website for recent figures on how much interest-rate risk and default risk a fund is taking. “Duration” is the standard gauge for rate risk: If the average duration of the fund’s holdings is five years, for example, that suggests that the fund’s share price would fall 5% for a one-percentage-point climb in rates. For default risk, look for the portfolio’s average credit rating or how the holdings are spread among different credit ratings.

As one point of comparison, the iShares Core Total U.S. Bond Market ETFAGG -0.24%which tracks the Barclays U.S. Aggregate Bond Index, has a duration of about five years and 70% of assets in triple-A bonds.

6. Do the managers and board members invest in the fund?

Many financial advisers favor funds whose portfolio managers and directors “eat their own cooking” by investing sizable sums of their own money in the funds. This is disclosed in a fund’s Statement of Additional Information, commonly available on fund websites. The data is supplied with ranges, not actual dollar figures. For example, as of March 31, Wallace Weitz had more than $1 million invested in each of four funds he manages, according to the Weitz Funds SAI.

Some fund firms also discuss their managers’ investments on their websites or in other materials.

7. How volatile is this fund compared with other choices?

Funds that bounce around less in price aren’t necessarily going to do better over time, but they are “easier for people to hold,” says Dan Culloton, associate director of fund analysis at Morningstar. With such funds, investors “are less likely to make the stupid psychological mistakes that many of us make,” such as panic selling after a fund has tumbled, he says.

A simple but not perfect way to gauge volatility is to compare the standard deviation of a fund’s returns over, say, the past three years to the standard deviation of its peers or an index. A higher figure indicates a wider range of monthly returns. Look under “Risk” on WSJ.com or “Ratings & Risk” on Morningstar.com.

8. For an ETF, what is the bid-ask spread?

When investors buy and sell conventional mutual funds, the price (excluding any commissions) is the “net asset value” of the fund’s holdings. With ETFs, by contrast, at any given moment, the price you would pay to buy is higher than what you would get to sell. That bid-ask spread will vary over time, but effectively adds to your cost, notes Paul Baiocchi, vice president of ETF analytics for IndexUniverse. It is typically wider for less-liquid investments.

An ETF’s average spread over the past 60 days is available on indexuniverse.com.

9. How does the manager really invest?

In considering an active fund, says Mr. Snowball, you want to try to understand the manager’s investing process and how he or she sees the world. That can show if there is “a compelling justification” for using this fund—and maybe help you remain comfortable with the manager during an inevitable rough patch.

Read the fund’s recent shareholder reports and any additional commentary on the website.

John Coumarianos, an investment manager in Northvale, N.J., favors managers who write investor letters in which “their voices come through.” He says that is more common at funds from small firms, such as the FPA and Third Avenue families, but he points to the American Funds complex as a standout among large companies.

10. Do payments from the fund company to my brokerage pose a conflict?

There’s typically a short notice in the prospectus indicating that payments from the fund or fund company to financial intermediaries may influence a brokerage or individual broker to recommend that fund over other investments.

For more information, check your brokerage’s website, says Mercer Bullard, an associate professor at the University of Mississippi School of Law. (You can try searching for “revenue sharing.”)

For instance, a disclosure from Morgan Stanley MS +1.64% lists more than 100 fund firms that made such payments to the brokerage in 2012; 37 of them are identified as “Global Partners” that “dedicate significant financial and staffing resources” to educational and marketing activities at Morgan Stanley and may have greater access to the firm’s representatives.

About bambooinnovator
Kee Koon Boon (“KB”) is the co-founder and director of HERO Investment Management which provides specialized fund management and investment advisory services to the ARCHEA Asia HERO Innovators Fund (www.heroinnovator.com), the only Asian SMID-cap tech-focused fund in the industry. KB is an internationally featured investor rooted in the principles of value investing for over a decade as a fund manager and analyst in the Asian capital markets who started his career at a boutique hedge fund in Singapore where he was with the firm since 2002 and was also part of the core investment committee in significantly outperforming the index in the 10-year-plus-old flagship Asian fund. He was also the portfolio manager for Asia-Pacific equities at Korea’s largest mutual fund company. Prior to setting up the H.E.R.O. Innovators Fund, KB was the Chief Investment Officer & CEO of a Singapore Registered Fund Management Company (RFMC) where he is responsible for listed Asian equity investments. KB had taught accounting at the Singapore Management University (SMU) as a faculty member and also pioneered the 15-week course on Accounting Fraud in Asia as an official module at SMU. KB remains grateful and honored to be invited by Singapore’s financial regulator Monetary Authority of Singapore (MAS) to present to their top management team about implementing a world’s first fact-based forward-looking fraud detection framework to bring about benefits for the capital markets in Singapore and for the public and investment community. KB also served the community in sharing his insights in writing articles about value investing and corporate governance in the media that include Business Times, Straits Times, Jakarta Post, Manual of Ideas, Investopedia, TedXWallStreet. He had also presented in top investment, banking and finance conferences in America, Italy, Sydney, Cape Town, HK, China. He has trained CEOs, entrepreneurs, CFOs, management executives in business strategy & business model innovation in Singapore, HK and China.

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