Fund I-Q No.2: Favorable Risk-Return Profile
  1. Perspectives on the Risk-Return Relationship
  2. Understanding Mutual Fund Returns
  3. Fund I-Q No.2: Favorable Risk-Return Profile
  4. Scoring Risk-Return Data

Fund I-Q No.2: Favorable Risk-Return Profile

By Richard Loth (Contact | Biography)

As mentioned previously, a mutual fund's risk-return profile is important for a number of reasons:

  • Common sense tells us that a fund investor should get a return equal to or better than the fund's risk rating.
  • A risk-return profile helps an investor to make individual fund choices that are consistent with the over all risk profile of his or her portfolio.
  • A risk profile is a handy screening device to determine whether a fund's investment advisor is chasing risky investments to boost fund performance.
Investment Quality No.2 relates to the fund manager's ability and commitment to managing a mutual fund's assets according to as a positive a risk-return spread as possible over the course of several years. (For related reading, see Why Fund Managers Risk Too Much.)

As is always the case with any financial indicator, fund risk-return ratings should not be looked at in isolation. It would be prudent to correlate these findings with the long-term (five to 10 years) total returns and the management costs of the fund. For example, in comparing two funds with equal performance records, the one with less risk would warrant a higher investment quality rating than the other.

It is worthwhile to look at the risk-return relationship of some mutual funds to see this fund criterion in action. Morningstar's fund report provides an easy-to-use rating, which is the one we will apply here to a selection of stock and bond funds.

After perusing the following fund information, which fund do you think goes to the head of the class for the best positive risk-return spread?

Large-Cap Stock Return Risk
Fidelity Contrafund (FCNTX) High Below-Average
Janus (JANSX) Average Above-Average
Vanguard U.S, Growth (VWUSX) Average Average
Marsico Focus (MFOCX) Above-Average Average
White Oak Select Growth (WOGSX) Average High
Bond Return Risk
Pioneer High-Yield (TAHYX) Average Above-Average
Fidelity Intermediate (FTHRX) Average Below-Average
Davis Appreciation & Income (APFCX) High Low

If you chose the Davis Appreciation & Income Fund, you have grasped the concept behind fund investment quality. In general, most mutual funds will have but one positive "notch," or spread, between their return and risk rating spread. The Marsico and Fidelity Intermediate funds are examples of this status, while the stellar Fidelity Contrafund has a two "notch" positive spread. The Janus, White Oak, and Pioneer funds all show negative spreads, which is a circumstance that should raise some serious concern for fund investors.

Return to the Main Menu.
Scoring Risk-Return Data

  1. Perspectives on the Risk-Return Relationship
  2. Understanding Mutual Fund Returns
  3. Fund I-Q No.2: Favorable Risk-Return Profile
  4. Scoring Risk-Return Data
  1. Qualitative Analysis

    Securities analysis that uses subjective judgment based on nonquantifiable ...
  2. Alpha

    Alpha is used in finance to represent two things: 1. a measure ...
  3. Profit and Loss Statement (P&L)

    A financial statement that summarizes the revenues, costs and ...
  4. Liquidity

    The degree to which an asset or security can be quickly bought ...
  5. Equity

    Equity is the value of an asset less the value of all liabilities ...
  6. Profit Margin

    Profit margin is part of a category of profitability ratios calculated ...
  1. How do I interpret a Security Market Line (SML) graph?

    The Capital Asset Pricing Model, or CAPM, shows the relationship between an asset's expected return and beta. The foundational ... Read Full Answer >>
  2. Can working capital be too high?

    A company's working capital ratio can be too high in the sense that an excessively high ratio is generally considered an ... Read Full Answer >>
  3. Can mutual funds invest in hedge funds?

    Mutual funds are legally allowed to invest in hedge funds. However, hedge funds and mutual funds have striking differences ... Read Full Answer >>
  4. What are the risks of annuities in a recession?

    Annuities come in several forms, the two most common being fixed annuities and variable annuities. During a recession, variable ... Read Full Answer >>
  5. Do financial advisors get paid by mutual funds?

    Financial advisors are reimbursed by mutual funds in exchange for the investment and financial advice they provide. A financial ... Read Full Answer >>
  6. Why is fiduciary duty so important?

    Fiduciary duty is one the most important professional obligations. It basically provides a much-needed protection for individuals ... Read Full Answer >>

You May Also Like

Hot Definitions
  1. Capitalization Rate

    The rate of return on a real estate investment property based on the income that the property is expected to generate.
  2. Gross Profit

    A company's total revenue (equivalent to total sales) minus the cost of goods sold. Gross profit is the profit a company ...
  3. Revenue

    The amount of money that a company actually receives during a specific period, including discounts and deductions for returned ...
  4. Normal Profit

    An economic condition occurring when the difference between a firm’s total revenue and total cost is equal to zero.
  5. Operating Cost

    Expenses associated with the maintenance and administration of a business on a day-to-day basis.
  6. Cost Of Funds

    The interest rate paid by financial institutions for the funds that they deploy in their business. The cost of funds is one ...
Trading Center
You are using adblocking software

Want access to all of Investopedia? Add us to your “whitelist”
so you'll never miss a feature!