A mutual fund prospectus is a managed fund’s introduction to you. The mutual fund prospectus should tell the prospecting investor several things including 1) how the fund is managed, 2) what the fund invests in, 3) why the fund invests in what it does and 4) how the fund performs financially. Forward looking guidance in a prospectus is useful, but shouldn’t be taken as gospel as much as the management’s informed opinion regarding the fund’s investments. This article will illustrate how to read a mutual fund prospectus in terms of understanding important sections and why they are useful. The Fidelity, February 2009 Contrafund Class A (FCNTX) Prospectus will be used as the example.
Review the mutual fund’s expenses:
The first thing a mutual fund investor may want to look at is the cost of investment such as management fees, transaction costs, front end costs and back end costs. If the fees are too high, they may offset the performance of a fund to such an extent that makes the investment unfit for specific investment objectives. Have a look at the linked to Fidelity Contrafund fee table, and look for what is not said or lightly alluded to rather than what is said and heavily emphasized. Three important things to look for are the following:
• Expense ratio
• Expense ratio source
• Footnote exemptions, caveats, conditions
Fee information is also provided in the ‘Fund Management’ section of the Contrafund prospectus and indicates how basic fees are calculated. Pay special attention to whether or not this fee is variable and how it is calculated. Additionally, add any taxes on dividends and capital gains to the cost basis to determine a more accurate potential return.
Compare the mutual fund’s share classes:
Share classes are quite important as each share class has different costs associated with it. Different funds may have multiple share classes such as A class, B class and C class. This particular fund consists of class A shares, however a similar fund with same name called the Fidelity Contrafund Class K (FCNKX) also exists. The difference between these two funds includes the expense ratio and minimum investment amountBeing exactly aware of what class A shares constitute and how they are managed is important because it can affect your investment objective. If the share classes aren’t adequately illustrated in the prospectus contact the fund’s investment representative for clarification of the share class terms. You may also want to do additional independent research on share class differences and their impact on investing.
Assess the fund’s performance over time:
The funds performance over the years will tell you what kind of investment return you’re more likely to achieve through this particular investment. For example, the Fidelity Contrafund has closely matched the S&P 500 index for the last 10 years as of 10.09. This means the fund could provide average returns during good economic and/or market conditions, and average losses during bad economic and/or market conditions. Earnings types and distribution options should be listed in the prospectus i.e. whether or not the fund earns dividends, how and when capital gains are distributed, and reinvestment plans. In this particular fund, these items are listed in the dividends section of the prospectus.
Review the fund’s investments and investment method(s):
What the fund invests in and how is also relevant and should be explained in a mutual fund prospectus. Some funds have strict guidelines and protocol for making investments and trading activity. The funds investment guidelines should match your risk levels and fund management preference. For example, the Fidelity Contrafund invests in common stocks and does not invest according to a specific protocol other than value investing per the fund management’s analysis. This information is found in the ‘Investment details’ section of the prospectus.
Read the mutual fund’s prospectus and investor instructions:
The investor instructions include how an investor can purchase mutual fund shares, how the shares are valued and methods by which an investor can purchase shares of the mutual fund. In the Fidelity Contrafund Prospectus, these instructions are located in the buying section of the fund. Of particular relevance in this section are the following three listed items in addition to policies and conditions through which buying and selling activity takes place.
• Minimum investment
• Investment account types
• Contact information for investors
Check fund management information:
For background information on the fund management begin by looking at the fund management section of the prospectus. This won’t always tell you a whole lot about the funds management but will point you in the right direction should you wish to perform additional research on the mutual fund. Fund Management is key to how well a mutual fund can perform. Experienced, knowledgeable and proven fund managers may have a higher probability of steering the fund well into the black for consecutive quarters and this can be demonstrated through the fund managers history through a complete business cycle.
Consider additional mutual fund factors:
There is a saying among some investors that goes ‘if the mutual fund prospectus has too many glossy pictures, don’t invest in it.’ Point being, a prospectus should be about how the fund is managed and how well the fund performs, and not necessarily how well it markets itself. This is so because a mutual fund doesn’t depend on sales as much as it depends on being well managed ie. Investors are important, but their reason for investing is often the fund itself, not the marketing of the fund.