Spend, Save and Invest Smartly

Portfolio Analysis



All mutual funds have a stated investment mandate that states whether the fund will invest in large companies or small companies, and whether those companies exhibit growth or value features. It is assumed that the mutual fund manager will adhere to the stated investment objective. It is a good start to understand the fund's specific investment mandate, but there is more to fund performance that can only be revealed by digging a bit deeper into the fund's portfolio over time.

1. Sector Weights

Sometimes fund managers will gravitate toward certain sectors either because they have deeper experience within those sectors, or the features they look for in companies force them into certain industries. A dependence on a particular sector may leave a manager with limited possibilities if they have not broadened their investment net.

To determine a fund's sector weight, we must either use analytical software. Regardless of how the information is obtained, the investor must compare the fund to its relevant indexes to determine where the fund manager increased or decreased his allocation to specific sectors relative to the index. This analysis will shed light on the manager's over or underexposure to specific indexes (relative to the index) in order to gain additional insight on the fund manager's tendencies or performance drivers.

The analysis can be as simple as listing the fund and relevant indexes side by side with a breakdown by sector. For instance, for a large cap manager, the simplest way to determine sector reliance is to place the fund's sector breakdown next to both the S&P 500 Growth Index and the S&P 500 Value Index. Both of these indexes exhibit unique sector breakdowns because certain sectors normally fall into the value category, while others fall into the growth category. Technology, known more as a growth sector, will have a higher weight in the S&P Growth Index than in the S&P 500 Value Index. Industrials, on the other hand, known as a value sector, will have a higher weight in the S&P 500 Value Index than in the S&P 500 Growth Index. A comparison of the fund relative to the sector breakdown of these two indexes will indicate whether the fund is in line with its stated mandate and reveal any over/under allocations to a specific sector. The key to this analysis is to perform it on both current as well as historical data in order to identify any tendencies the fund manager may have.

2. Attribution Analysis

There are fund managers who claim to have a top-down approach and others that claim to have a bottom-up approach to stock-picking. Top-down indicates that a fund manager evaluates the economic environment to identify global trends and then determines which regions or sectors will benefit from these trends. The fund manager will then look for specific companies within those regions or sectors that are attractive.

A bottom-up approach, conversely, ignores, for the most part, macroeconomic factors when searching for companies to invest in. A manager that employs a bottom-up methodology will filter the entire universe of companies based on certain criteria, such as valuation, earnings, size, growth, or a variety of combinations of these types of factors. They then perform rigorous due diligence on the companies that pass through each phase of the filtering process.

In order to determine whether a fund manager is essentially adding any value to performance based on asset allocation or stock picking, an investor needs to complete an attribution analysis that determines a fund's performance driven by asset allocation versus performance driven by stock selection. Attribution analysis, for instance, can reveal that a manager has placed incorrect bets on sectors but has picked the best stocks within each sector. Using this instance, this manager must have a bottom-up approach. If the manager's mandate describes a top-down methodology, this might be a cause for concern because we have discovered that the fund manager has done a poor job of asset allocation (top-down).

Mutual Funds
Mutual Funds