Year-end letters provide opportunities for candor, explanation, and connection.
Sometime in the past month, you should have received the annual reports for some of your mutual funds in the mail or online. (Funds that end their fiscal year on Oct. 31 sent the reports a couple of months earlier.) These documents contain much of interest, such as a fund's holdings, expense ratio, turnover rate, and the amount of money paid to its board of directors. Most of this information appears in a standardized format. But one section can take almost any shape the fund company or manager wants: the letter to shareholders.
This letter, or "management commentary," is worth reading. In many cases, it can provide you with a window into your manager's thinking and provide insights that would be difficult to obtain even by intensive study of all the other available information. And if the letter fails to take advantage of that potential, that in itself can be telling.
What Should Be There
While a rewarding letter can appear in a variety of styles, it should contain certain elements. Most important is clear writing. Without that, all else would be of little use.
Managers must present their points in a way that's easy to understand, and lively enough to grab and keep the reader's interest. A boring or incomprehensible piece will not be read. Moreover, one reason to peruse the letter is to gain an appreciation for the personality and character of the man or woman you've entrusted with your money. That cannot come through if the prose sounds as if it were written by a robot (or worse, a bureaucrat).
This does not mean that managers must strive to be entertainers, with reports full of witty anecdotes and one-liners. If a jovial tone isn't natural, they shouldn't force it. The important thing is for a real person to show through.
Of course, the content is equally important. Shareholder letters should include plenty of details, not just vague overviews. They should discuss specific decisions made about individual securities or about types of holdings, including the reasons for these moves. If certain stocks, sectors, or countries are vastly over- or underweighted in the portfolios versus indexes or peers, or are controversial, the letters should tell shareholders why they were purchased, sold, or maintained at the same weighting. Did the manager decide to make a change of course at some point during the year? If so, the letter should explain to shareholders the thinking behind the action.
Evaluating performance is important, too. This section should not consist only of bare-bones descriptions such as "Contributors included sectors A, B, and C, and detractors included stocks X, Y, and Z." (Too many letters use nearly that exact language without further elaboration.) Mistakes require special attention. Very few managers come right out and say, clearly and unequivocally, "My decision to buy X (or not to sell Y) was a mistake," and explain why they did so and what they learned from the experience.
Perhaps managers--and their fund company overseers--think an admission of error will raise doubts about competence. But shareholders who expect perfection probably won't be long-term shareholders anyway. In fact, though it might seem counterintuitive, clear explanations of mistakes can instill confidence in shareholders. Such discussions provide evidence that their manager is a straight shooter. More important, they show that he is a thoughtful, analytical type who knows when something has gone wrong and who tries to learn from the experience.