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Course 109
Important Fund Documents, Part 2


A mutual fund's shareholder report is part biography, part blueprint, and part ledger book.

A good shareholder report is like a biography in that it sets out what happened to the fund over the past quarter, six months, or year, and why. It's like a blueprint because it sets before you all the investments stocks, bonds, and other securities that the fund has made. And it's like a ledger book because it discloses a fund's costs, profits, and many other financial facts. Mutual funds are required by theSEC to release a shareholder report at least twice a year, though some fund families publish them quarterly.

Not all of the following items are required by law to appear in a mutual fund's shareholder report. TheSEC allows some of the information to be included in other documents, such as a fund's prospectus or Statement of Additional Information. However, a good report will contain all of the elements discussed below.

Letter from the President

Typically, the first item you'll find in a shareholder report is a letter from the president of the company that advises or manages your fund. The best letters will contain straightforward, useful discussions of the economic trends that have affected the markets during the past six or 12 months and provides some context for evaluating your fund. Poor letters, in contrast, will discuss anything but the current financial climate and the performance of the fund family's offerings.

Letter from the Portfolio Manager

This is a fund-specific examination of the recent performance and therefore much more important to you as a fund shareholder. Well-written shareholder letters discuss individual stocks that the fund owns and the industries in which the fund invested. A good manager letter will also explain what broad market trends might have fueled or hindered your fund's performance. Finally, most managers will give you an indication of what you can expect from the fund in the future, given an unchanged strategy.

Investors should demand a lot from shareholder letters, particularly in times of declining performance. If shareholder reports leave your questions unanswered, let your mutual fund company know. (Note: Many fund companies have begun sending out portfolio-manager letters that are separate from their shareholder reports, rather than bundling them together.)

Recent Fund Performance

The portfolio manager's report is generally followed by a discussion of recent performance. The report should compare your fund's performance to both a benchmark, such as the S&P 500 Index (the standard benchmark for large-company stock funds) or the Russell 2000 Index (for small-company funds), as well as to the average performance of funds with similar investment strategies.

When evaluating your fund's performance, be sure that the benchmark the fund chooses is appropriate for its style. For example, a technology fund shouldn't compare itself to the S&P 500 and nothing else; it should measure its performance against a technology benchmark.

In addition to benchmark comparison, the report should give you an idea of how the fund has performed over various time frames, both short and long term.

Portfolio Holdings

Funds often list the portfolio's largest holdings and provide some information about what these companies do or why the manager owns them. Some reports will also indicate, via a pie chart or table, the sectors in which the fund is heavily invested.

This general overview is complemented by a complete list of the fund's portfolio holdings including stocks, bonds, and cash as of the date of the report. These holdings are usually segmented by industry. (Foreign funds may segment by country.) While you might not recognize all the names of the stocks in the portfolio, this listing is useful if you're wondering whether the fund is holding many names in one industry or making a few large selected bets.


Don't forget to read the fine print. In the footnotes, you can find out if fund managers are practicing such strategies as shorting stocks or hedging exposure to foreign currency, which can significantly affect the fund's performance.

Footnotes can also provide insights into particular portfolio holdings. For instance, they may designate certain holdings as illiquid securities and 144a securities, which means they're more difficult to trade than plain common stocks.

Financial Statements

A fund's annual report concludes with its financial statements. Brace yourself: There's a lot of data here. In fact, this is where we get a lot of the data for the fund data reports shown on and, if we do say so ourselves, we do a pretty good job of clarifying that data and putting it into context.

However, if raw numbers are your thing, you should take a look at the following: First, examine what's known as the fund's Selected Per-Share Data. This is usually the last page of actual information, located just before the legal discussion of accounting practices. Here you'll find the fund's NAVs, expense ratios, and portfolio turnover ratios for each of the past five years (or more). Check to see if the fund's expense ratio has gone down over time (we hope it has) and whether its turnover rate has changed much (if so, you may want to find out why).

Cost-conscious investors can check out the breakdown of fund's expenses, including management fees, under the Statement of Operations. In addition, you can find out how much in unrealized or undistributed capital gains you're facing, using the Statement of Assets and Liabilities. (A gain is unrealized when a stock has gone up but the fund hasn't sold it. As soon as the fund sells the stock, it becomes a "realized" gain, which has to be distributed to shareholders. We explored this concept in Lesson 104.)

What To Do Next

You can request a prospectus, SAI, or annual report by phone, by direct mail, and sometimes by e-mail. Many funds also make this literature available for download at their Web sites. All mutual funds file their prospectuses, shareholder reports, and SAIs with the SEC. You can view these at the SEC's Web

While we suggest that you begin your fund evaluation with these documents, we don't think you should stop there. Seek out third-party sources, such as Morningstar, to help put your fund into context. Compare it with other funds that have similar investment approaches. You should evaluate how its costs stack up, if its performance is competitive, and if it compensates for the risks it is taking on.

Quiz 109
There is only one correct answer to each question.

1 Where are you most likely to find an explanation of why your fund performed the way it did during the past year?
a. In the president's letter.
b. In the portfolio manager's letter.
c. In the footnotes.
2 A good shareholder report will compare your fund's performance with what?
a. Funds that practice similar styles.
b. An appropriate index.
c. Both.
3 Turn to the Per-Share Data for:
a. The turnover ratio.
b. A list of what stocks the fund owns.
c. A breakdown of expenses in dollar terms.
4 Where in the shareholder report are you most likely to find information about whether a fund shorts stock or practices other complex strategies?
a. In its Portfolio Holdings.
b. In the portfolio manager's letter.
c. In its footnotes.
5 Where should you turn for information about a mutual fund?
a. Its documents.
b. Third-party sources.
c. Both.
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