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.

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