Measuring Mutual Fund Performance

The performance of a mutual fund is usually measured by the average annual return or the total return for a selected period such as one, three, five or ten years. These measures are convenient for bookkeeping purposes because they allow you to compare the performance of different funds. But investors buy and sell funds at irregular intervals. One investor may hold a fund for 6 years while another may sell after 13 years. Therefore, the conventional return figures are narrow in focus and do not reveal the entire story about a funds performance.

Also, many investors and professional money mangers judge a mutual fund's performance relative to a broad stock market index like the S&P 500. A fund is said to have outperformed the market if its total return is greater than the total return of the market index. Investors are pleased when they beat the market and a fund manager's performance is based on how much his or her fund beats the market.

This article discusses a comprehensive measure of performance that compares the returns of a mutual fund with the returns of a broad market index. The methodology uses the Complete Trading Model (CTM) to compute the percent returns for all possible buy and sell combinations for a selected period for the mutual fund and the market index. The measure tells the investors the proportion of the fund's buy and sell combinations that beat the corresponding buy and sell combinations of the broad market index.

For a given period you compute the percent return for each buy and sell combination for the mutual fund. Next do the same for the broad market index. Then for each buy and sell combination subtract the percent return of the market index from the percent return of the mutual fund. If the difference is greater than zero, the mutual fund beat the market index for that buy and sell combination. Add up the total number of buy and sell combinations that beat the market index for the period and divide the sum by the total number of buy and sell combinations for the period. The quotient tells you the proportion of the buy and sell combinations that beat the market index.

The proportion is based on all possible holding periods from one month to the total length of the period being analyzed. So it is not limited to a few holding periods like one, three, five or ten years.

A mutual fund with a high proportion is a better performer than one with a lower proportion. For example, you would want to own a mutual fund that beat the S&P 500 90 percent of the time versus one that beat the S&P 500 only 20 percent of the time.

The following examples discuss two funds; one that consistently beat the S&P 500 and one that did not.

Magellan Fund Beats the S&P 500

The Fidelity Magellan fund (FMAGX), a popular fund that invests in large cap stocks, has been a winner for investors. From September 1986 through August 2004, 19,499 (83.98%) of the fund's 23,220 monthly buy and sell combinations beat the S&P 500 percent returns. So FMAGX consistently out performed the S&P 500.

Dreyfus Growth Opportunity is a Loser

The Dreyfus Growth Opportunity (DREQX) fund, another large cap fund, has been a loser for investors. Only 4,997 (18.81%) of 26,565 monthly buy and sell combinations beat the S&P 500 from June 1985 through August 2004. DREQX consistently under performed the S&P 500 and is a fund you want to avoid.

Summary and Conclusions

Knowing how often that a mutual fund beats the S&P 500 is a useful piece of data. You can use it with other standard measures of performance to evaluate the past performance of a mutual fund.