A Statistical View of Mutual Funds

Anytime you bring up the word fees with mutual funds; you bring up some controversy. In the current market environment, many investors question the validity of fees. Why pay management fees when you are not making money? Is this question valid? I think so. Will there be changes to the fees in the mutual fund industry? I’m not so sure. Do I have the answers? Absolutely not. Lets start by walking through some of the different fees when it comes to mutual funds:

Management fee

There’s much more to performance than just annualized performance. In fact in a past article, I talked about some of the performance data to look at other than just annualized performance. (May 25, 2001 –

If you want to get more technical, you will need to look at some key statistical data on the risk and return of funds which is not as accessible as performance data. However, any qualified financial advisor should be able to get you this information. I will do my best to translate technical jargon into English using, the Trimark Select Growth Fund as an example. I find this one of the most useful ways to help you understand these measures. Here it goes:

  1. Sharpe ratio – the Sharpe ratio measures the return of a mutual fund compared to the risk free rate of return. The risk free rate of return is the 91-day t-bill rate. This should be similar to money markets or short term GICs. Often this ratio is used to determine if a mutual fund is able to beat GICs.

    The Trimark Select Growth Fund has a Sharpe ratio over the last 5 years of 0.57. The range of Sharpe Ratios for global equity funds went from as low a -1.11 to a high of 0.94. A positive Sharpe ratio means the fund did better on a risk adjusted basis than the 91-day t-bill rate. In other words, the higher the Sharpe ratio, the better.

    The Sharpe ratio tells you about history but it does not tell you anything about the future. Just because a fund has a positive Sharpe ratio for the last 5 years does not mean it will outperform GICs for the next 5 years.

  2. Treynor ratio – the Treynor ratio is similar to the Sharpe ratio. Instead of comparing the fund’s risk adjusted performance to the risk free return, it compares the fund’s risk adjusted performance of the relative index.

    The Trimark Select Growth Fund has a Treynor ratio of 11.52. Just like the Sharpe ratio, the higher the number the better. The range of ratios for global equity funds is a low of -20.91 to a high of 32.00.

  3. Alpha ratio – If you are trying to see if a mutual fund has beat the performance of it’s relative index, you should take a look at the alpha ratio. In more simple terms, if you want to see if the Trimark Select Growth Fund beat the MSCI World Index, then you look at the alpha.

    The Alpha ratio for the last 5 years for the Trimark Select Growth fund is 0.46. To put this in perspective, if the number is greater than 0, then we say it has a positive alpha. In this case, over the last 5 years, the Trimark Select Growth Fund has been able to out perform the MSCI world Index. The greater the number, the greater the out performance. The range of alpha’s for global equity funds is -0.87 to +1.72.

  4. Beta ratio – where the alpha looks at excess returns over the index, the beta looks at excess risk over the index. So we know that the Trimark Select Growth Fund has out performed the index in the last 5 years but how much risk did it take to do so?

    The beta for the Trimark Select Growth fund is 0.61. In context, the benchmark for the beta measure is 1. If you have a beta of 1, it is said that you have the same risk as the market. If you have a beta of 0.61, it is said that you have experienced about 61% of the risk of the market. In other words, you have taken less risk than the market.

    Betas and Alphas go hand in hand. Ideally, you want a fund with a low beta and a high alpha. This means you have found a fund that has outperformed the index experiencing less risk than the index.

How should you use these ratios?

My point to providing this is really not to confuse you. Rating and analyzing mutual funds is an imperfect science. There are many times that fund movements cannot be explained by any statistics because of random activity.

My point has always been that people place far too much emphasis on performance alone and the most readily available information is the only information that is used to evaluate performance. If you want to employ better research, you may want to look at some of these ratios to help determine how well a fund has performed in relation to risk and return of GICs and other benchmark indexes.

I recognize that these terms may be as confusing to you as the medical jargon is to me. There are complete textbooks that try to describe what I have tried to communicate in a short 1 page article. However, as technical and confusing as it may be, they may be important figures to look at to try and understand the merits of a particular mutual fund.

Written by Jim Yih

Jim Yih is a Fee Only Advisor, Best Selling Author, and Financial Speaker on wealth, retirement and personal finance. Currently, Jim specializes in putting Financial Education programs into the workplace. For more information you can follow him on Twitter @JimYih or visit his other websites JimYih.com and Clearpoint Benefit Solutions.

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