Comparing two funds properly

Fund comparison in practice generally consists of looking at past returns, which is the weakest available basis for a decision.

Start with the mandate

What each fund is trying to do.

Two funds are only comparable if they are attempting the same thing.

A global equity fund and a developed-markets fund are not comparable, and neither is comparable to a fund with a factor tilt or an exclusion policy.

Which means reading the objective and the index tracked before anything else.

A comparison between funds with different mandates measures the mandate rather than the fund.

Compare the holdings

What you actually own.

Number of holdings, which indicates breadth.

Top ten holdings and their combined weight, which indicates concentration.

Geographic breakdown, which frequently differs from the fund name.

Sector breakdown.

Company size distribution.

And for bond funds: credit quality, duration and issuer concentration.

Two funds with similar names can hold substantially different things, and this is where the difference lies.

Compare total cost

All layers.

The ongoing charge figure.

Transaction costs within the fund, where disclosed.

Any performance fee.

The bid-offer spread for exchange-traded funds.

Dealing charges on your platform.

Currency conversion if the fund is denominated differently.

And check whether a cheaper share class of the same fund exists, which is common and which platforms do not always move you to.

For index funds: tracking

The relevant quality measure.

Tracking difference is the gap between the fund's return and the index return over a period, which reflects costs, cash drag, tax on dividends and securities lending revenue.

A fund with a slightly higher charge and better tracking can deliver more than a cheaper one that tracks poorly.

Comparing several years of tracking difference is the useful check, and it is available in fund documentation.

Tracking error, which measures the volatility of the difference, matters less for a long-term holder.

For active funds: differentiation

The relevant check.

Active share, where disclosed, measures how much the portfolio differs from the benchmark.

A fund charging active fees with low active share is paying for index-like exposure, which regulators in several jurisdictions have investigated.

Manager tenure, since a strong record under a departed manager is not informative.

Fund size relative to strategy capacity, since large funds in small markets face constraints.

And turnover, which drives transaction costs.

Structural details

Which affect the practical outcome.

Domicile, which determines tax treatment for holders in different countries and which can materially affect net returns.

Replication method: physical, sampled or synthetic.

Accumulating or distributing, and the tax treatment of each in your jurisdiction and account.

Currency hedging, particularly for bond funds.

Fund size, since small funds close and force disposals.

And securities lending policy, which generates revenue and introduces counterparty risk.

Where performance is useful

Narrowly.

For index funds, comparing performance against the index rather than against other funds, which is a tracking check.

For any fund, looking at discrete annual returns rather than cumulative figures, which can be dominated by one exceptional period.

And looking at behaviour during the worst period available, which tells you what to expect.

Comparing raw returns between funds with different mandates tells you almost nothing.

The practical process

In order.

Confirm both funds are attempting the same thing.

Compare the actual holdings.

Compare total cost including platform charges.

For index funds, compare tracking difference over several years.

Check structural details: domicile, replication, share class, size.

Check the worst historical period and whether you could hold through it.

And choose the cheaper one where everything else is equivalent, which it frequently is.

When the answer is neither

Worth considering.

If two funds are being compared because both were recommended, the prior question is whether either fills a gap in the portfolio.

Adding a fund that duplicates existing exposure adds cost and complexity without diversification.

Which means the comparison should be preceded by asking what the holding is for, and whether the answer is anything other than that it was suggested.

General information only, not investment advice. Investments can fall in value and past performance does not indicate future returns. Consult a regulated financial adviser.