Defining Mutual Fund Return: a Black Comedy

Black comedy, as in dark, little or no light visible. That's how things are regarding the meaning of the word Return when used for mutual fund performance.

Reader Marypat in a comment on my last post says she is a new investor and asks a simple question: "I was wondering if the returns they report for mutual funds would already include the payment of the MER. For example, one fund shows a 1 year return of 3.8% but it also has a MER of 2.55%. Does this mean that my return is actually 3.8%, or is it 3.8% less the MER?" The simple answer is that the reported Return is net of / after deduction of the MER, i.e. in the example, 3.8% net. The MER gets automatically deducted from the fund by the managers and reduces the fund's asset value. When the net asset value is used to calculate the Return, the MER money is already gone.

MER is not the only Returns-reducing cost, though. There are other costs that get deducted and reduce reported Returns, notably trading expenses and GST. The fund Return also should include the assumption that all distributions are reinvested instead of being received in cash. Finally, there are other possible or variable costs that will reduce Returns but which are NOT shown in reported performance - fund switching fees, one-time front-end sales fees or back-end early redemption fees and income tax (see a previous post on MER vs TER).

I say "should include" because the exact description of how mutual fund Return is calculated seems impossible to find on any official website!

Try to find an FAQ, a footnote in fine print, a pop-up definition in GlobeInvestor or in Morningstar.ca that explains the performance numbers displayed for a fund. Good luck. For a random fund picked from a recent Globe article on Lipper's Top Mutual Funds Over Three Years - the Brandes Emerging Markets Equity Class A - here is the GlobeInvestor Brandes fund info and the Morningstar info. See any explanation of Returns on either website? Another mutual fund database and comparison site, FundLibrary.com, had no detailed definition of Return that I could find under Novice Investor or Q&A. The Glossary entry for Return had this definitional piece of fluff - "The amount of money earned by an investment".

Go to the Investment Funds Institute of Canada "The Voice of Canada's Investment Funds Industry" to look in their Investor Centre for an FAQ. Sorry, nothing. Does the Mutual Fund Association of Canada page For Investors have anything? Nope. Does the Canadian Securities Administrators Investing Tools section, including the hopeful looking Understanding Mutual Funds document contain the answer? Keep looking.

Does the regulatory body Ontario Securities Commission new Point of Sale Disclosure for Mutual Funds document Fund Facts contain the explanation? It's better! - "Returns are after expenses have been deducted" and then itemizes various expenses and fees (except for the GST, which isn't there at all). But there should be a more explicit explanation of which expenses to the investor are included or excluded in Returns data. Are those expenses with a capital E - i.e. only those in item 2) Fund expenses of the How much does it cost section, or possibly the 1) Sales charges and 3) Other fees too? It is a bit artificial to describe the fund's Returns only in strict terms as those after costs directly deducted from the fund on an on-going basis, instead of the investor's Returns which come after deduction of all the other charges, taxes and fees. Illustrations using typical examples e.g. median or average holding period for mutual funds would be very revealing. Apart from paper disclosure, it would be useful for mutual fund companies to be obliged to provide historical Returns calculators on their website that can incorporate holding periods and tax rates for funds.

The Investor Education Fund content, created especially for consumers by an organization funded by the OSC and copied on the Globe and Mail website, is positively befuddling in its What will it cost to invest in mutual funds? First it says "When your account statement shows you your return, what you see is what the fund made after costs." Then it lists the top three costs for mutual funds and includes the front- and back-loads that are NOT part of Returns figures cited by one and all. Thanks for the help. Please don't help us any more.

The mutual fund company Brandes Investment Partners includes a note at the bottom of its Fund Performance document - "The indicated rates of return are the historical annual compounded returns including changes in unit value and reinvestment of all distributions and do not take into account sales, redemption, distribution or optional charges or income taxes payable by any security holder that would have reduced returns." But what the heck does the statement preceding it mean - "Commissions, trailing commissions, management fees and expenses all may be associated with mutual fund investments"? We are left wondering how the MER and other expenses were treated in calculating those Returns. To figure it out, you have to already know that the MER causes a "change in unit value".

I've taken some liberty with regards to the meaning of Black Comedy, but let's try to avoid the approach of Humpty Dumpty in Alice In Wonderland:
`When I use a word,' Humpty Dumpty said in rather a scornful tone, `it means just what I choose it to mean -- neither more nor less.'

`The question is,' said Alice, `whether you can make words mean so many different things.'

`The question is,' said Humpty Dumpty, `which is to be master - - that's all.'