A 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. Funds are required by the FSA 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 fund's shareholder report. The FSA allows some of the information to be included in other documents, such as a fund's prospectus. However, a good report will contain all of the elements discussed below.
Letter from the Chief Information Officer
Typically, the first item you'll find in a shareholder report is a
letter from the CIO 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 provide 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
The shareholder report may also contain a letter from the fund’s manager
and, as with the CIO’s statement, this would hopefully contain
information on how external factors have impacted the fund’s performance
and asset allocation.
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, 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 FTSE 100 index 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 recognise 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.
Footnotes
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, the footnotes of US fund Baron Asset's December 31, 2001, report revealed that the fund held substantial enough positions in some stocks that they were deemed "affiliates." Other stocks were noted 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 Morningstar
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 located towards the end of the report, just before the legal discussion of accounting practices. Here you'll find the fund's net asset values and expense ratios for each of the past five years (or more). Among other things, check to see if the fund's expense ratio has gone down over time (we hope it has).
Cost-conscious investors can check out the breakdown of fund's expenses, including management fees. UK funds have had to disclose total expense ratios (TERs) in half-yearly accounts since 2007. In addition, you can find out how much in unrealised or undistributed capital gains you're facing (a gain is unrealised when a stock has gone up but the fund hasn't sold it. As soon as the fund sells the stock, it becomes a "realised" gain, which has to be distributed to shareholders. We explored this concept in earlier lessons.)
What to do next
You can request a prospectus or annual report by phone, by direct mail,
and sometimes by e-mail. Many funds also make this literature available
for download at their websites.
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.
For general information on investing, savings, tax and benefits, the government's Money Made Clear web site offers information across a broad range of topics. Of course, Morningstar's Learning Centre is growing day by day, so be sure to check back regularly for more investing lessons and tips.
