| By: | Dan Hallett, B.Comm., CFP |
| Senior Investment Analyst |
Time and time again, we've been told to build portfolios by starting with a solid foundation of value oriented buy-and-hold funds, then round things out with more aggressive and specialty holdings - good idea though not everybody buys into that philosophy. But what we otherwise consider conservative, or core, holdings are sometimes not what they appear to be. Five funds that are often used by investors as core conservative holdings will be unveiled to show what's really under the hood because they're not as conservative as you think.
The turnover rate measures what proportion of the portfolio is traded or "turned over" each year. Another way to describe turnover is to invert it and call it an average holding period. For instance, a turnover rate of 80% is the same as saying that the average holding period is 1.25 years (1.0 + 0.8), on average. Since the fund industry always preaches to investors that they should "be patient" and "buy for the long term", it's a good idea to make sure the fund you choose maintains that same philosophy, in practice. So while some aggressive funds are well known for their quick gun-slinging style, other funds that appear to be more conservative actually trade more often than you get your oil changed.
Heavy Trading Culprits
Global Strategy Canada Growth (Tony Massie)
Tony Massie has built a reputation for his stingy value style, always speaking of his holdings in relation to their break-up value - a true sign of a strict value discipline. But here's the problem: when stocks reach their target price, Massie pulls the trigger. To illustrate this in the context of this fund, Massie turned over his portfolio an average of 3.8 times in each of the past two years. In other words, he held the average stock less than 14 weeks (1 + 3.8 x 52) over the course of a two year period ending September 30, 1999. Okay, Massie's team trades a lot, but have they made any money?
To be fair, this fund's lack of performance over the past couple of years is largely due to the market's shunning of value stocks, especially some of the more traditional industrial firms found in this fund. That said, this fund has the dubious honour of having been outperformed by most in its group for six straight calendar years (1994 - 1999) and for the first half of 2000. And only once over that period has it reached as high as third quartile.
Unfortunately, this family doesn't offer any real alternative if it's a buy-and-hold fund you're after. Even star manager John Sartz doesn't quite fit the bill. Though he'll tell you he flips about 20% of his portfolio each year (based on the number of stocks), he's much more active on a market-weighted basis (i.e. the base for calculating portfolio turnover). Sartz has turned over his mid-cap Canadian Opportunities fund nearly once per year over the past two years (average of 93.9% per year). But Sartz has had good success since this fund's inception, spending about half of that time in the top quartile and the other half in the bottom quartile. And during the first half of the year, he has captured the rebound in value stocks quite nicely, while still riding the wave of high tech's success.
Spectrum United Canadian Equity (McLean Budden)
At the mid-point of 1999, Kiki Delaney marched her firm over to Trimark to launch the Enterprise funds, after managing this fund since 1992. Some manager shuffling left the capable team at McLean Budden in charge. Despite the changing styles over the years, this fund has always been a rather conservative growth fund. But the addition of McLean Budden in 1999 will likely see a significant run up in trading activity. Delaney's average turnover rate of about 35% translates into a holding period of nearly three years. This fund, under McLean Budden's direction, flipped 84.7% of its portfolio during 1999 - a holding period of just over one year. McLean Budden's own Canadian Equity Growth fund (a no-load retail offering) has tended to hold stocks less than a year, on average, with a turnover rate of 115% per year over the past two years. However, it's worthy to note that for the six months ended March 31, 2000 turnover has been about 50% (annualized) on the Spectrum United Canadian Equity fund. But those holding this fund in a taxable account beware, you could be hit with a significant distribution this year. Though the fund has realized sizeable gains this year, this is just a warning because distributions can't be known with any certainty until late November.
As for performance, McLean Budden hasn't missed a beat since stepping in (top quartile in 1999 and the first half of 2000). They use a much different approach than either of their predecessors on this fund, with an underlying objective of making sure they keep pace with the index. More common in the pension world, this fund combines the best ideas of McLean Budden's growth and value teams. Brian Dawson and Susan Shuter look at the changes made by McLean Budden's institutional team, then meet up to a week later to discuss and implement similar changes on this fund. What is it that makes this an index-beating approach? They make sure that they have industry weightings that are very similar to the TSE 300, but buy different stocks in different proportions. If, for instance, industrial products make up 40% of the index, this fund will have between 30% and 50% in industrials (0.75 to 1.25 times the index weighting). But while they'll buy Nortel they're not likely to let it ride up to the index's 30% + weighting. They have so far succeeded at adding value by taking very slight sector bets and by scoring big points on stock selection.
Since the fund combines both value and growth styles, it's what is known as a "style neutral" fund in that it doesn't commit 100% to any one style. Recent research has supported this approach, hence the wave of multi-manager fund launches by many firms. This is a good core holding, but if you want something with a true buy-and-hold approach, look the Canadian Investment Fund in this same family. Lead managers Kim Shannon and Gaelen Morphet are much more value-oriented (relative value), a style that can test investors' patience but provides greater downside protection.
Altamira Dividend (Ian Joseph & Frances Connelly)
What would you say if you were told that your stodgy dividend fund held stocks for about 15 weeks, then traded them? You'd probably be unpleasantly surprised, especially when you see the trading commissions that were generated. Altamira's website says the goal is to "achieve the maximum level of dividend income as is consistent with prudent levels of capital preservation and liquidity". Sounds conservative doesn't it? During 1999, this fund held its stocks an average of just over 15 weeks (i.e. turnover rate of 336.5%). Of course not every stock in the fund is traded every 15 weeks - some are longer term holds while others are more heavily traded.
Last month's article focussed more on the impact of trading costs, but I mention it in this specific case since a big chunk of this portfolio is invested in preferred shares. As far as risk and return goes, preferreds are similar to corporate bonds (in between stocks and gov't bonds). Overall, it's very much like an aggressive balanced fund so fees are very important since they can eat away at profits from the portfolio, especially on the fixed income side (i.e. preferred shares). Trading costs (and other expenses) don't show up in the MER. So it's important to know that the heavy trading in this fund drove total fees to 2.71% in 1999, much more than the 1.62% published by Altamira. The impact on returns is illustrated by the fact that lower interest rates during the latter part of the 1990s put a tighter squeeze on this fund's returns as trading activity has increased over the past five years. Going forward, lower returns are expected from this fund if trading activity persists at current levels.
As for buy-and-hold alternatives, there aren't any in this family since Altamira is probably one of the heaviest traders (and best customers) on Bay Street.
BPI American Equity Value (Paul Holland and Jon Sorensen, BPI Global Asset Management)
C.I. Funds describe this fund's management style as a "bottom-up value-oriented approach to focusing on high quality, large cap American companies that are global leaders in their industries". What you'll find in the fund's annual report are numbers that are staggering. Over the past two years, this fund has traded so often that, on average, it tends to hold a stock for less than 10 weeks. Also, despite its name, it is not a value fund. It has substantial positions in pricey technology issues (i.e. in industrial products and communications). While the managers do pay some attention to valuations, they are growth managers first and foremost. And if they're optimistic on growth, they'll be willing to pay a high entry fee now in return for rosy future expectations.
As for performance, this fund boasts a stellar track record dating back to 1989. Originally, managed by Lazard Frères Asset Management, this fund was taken over by BPI Global Asset Management (BPIGAM) in June 1997. BPIGAM kept this fund rolling right along with great stock picking. The fund has beaten most funds in its class (i.e. 1st or 2nd quartile) in seven of the last ten calendar years, in addition to the first half of 2000. So investors have reaped huge rewards as Holland and Sorensen have overweighted technology over the past couple of years. The curious thing is that its style screams of active management, but its top holding (at 6.1%) as of the end of June were S&P 500 depository receipts (SPDR) - index participation units that track the S&P 500 index. This seems to contradict what they're otherwise trying to do - beat the index.
While this is a great fund, the heavy trading might turn you off. If that's the case, there may not be many alternatives in this family. But then again, there aren't many choices anywhere for low turnover US equity managers. Admittedly, US equity managers that simply buy and hold are few and far between. The average turnover among US-based money managers is close to 100% per year.
Greenline DJIA 30 Index - A (Tim Thompson & Craig Gaskin, TDAM)
Tracking the Dow Jones Industrial Average index, this fund buys 30 of the largest companies in the United States. In 1999, the fund had a turnover rate of 113.1%, extremely high for a blue chip index fund. There are, however, a few explanations for this uncharacteristically high rate. First, the fund tracks an index with a tight number of stocks. It only takes few changes to make a significant impact. Second, the "no brainer" index approach means that changes are made regardless of the tax or cost consequence to unitholders - it mimics the index's actions. Third, with assets of just $30 million at the end of 1999 (it has grown to ~ $50 million) an influx of cash can cause lots of rejigging of the fund. During 1999, unitholders poured $7.6 million into this index fund causing just that effect on the small asset base. Once assets grow substantially and cash flows as a percentage of assets are reduced, the turnover impact should be substantially reduced. But at the current asset size, high turnover remains likely for this fund.
Aside from those issues, performance has been underwhelming, with a mixed relative showing in its brief history thus far. If it's index investing you're after, a S&P 500 (or Wilshire 5000) index fund will provide you with much lower turnover and broader coverage.
To be clear, most of the funds profiled above are in fact good portfolios (table I below summarizes the figures). But if it's buy-and-hold you want, you may want to explore other alternatives. Alternatively, five of the many great buy-and-hold funds for your North American stock component are profiled below.
Table I: High Turnover Funds
| Fund Name | 1998 Turnover | 1999 Turnover | 1996 Quartile | 1997 Quartile | 1998 Quartile | 1999 Quartile | Jun 2000 Quartile |
| Global Strat Canada Growth* | 399.3% | 368.0% | 4 | 3 | 4 | 4 | 4 |
| Global Strat Cdn Opportunities* | 109.2% | 78.6% | n/a | 1 | 4 | 4 | 2 |
| Spec United Canadian Eq* | 36.4% | 84.7% | n/a | n/a | n/a | 2 | 1 |
| McLean Budden Cdn Eq Growth | 113.7% | 116.5% | n/a | 1 | 2 | 2 | 1 |
| Altamira Dividend | 282.7% | 336.5% | 1 | 1 | 4 | 1 | 2 |
| BPI Amer Eq Val | 519.5% | 590.4% | n/a | 2 | 1 | 1 | 2 |
| Greenline DJIA Ind | 0.7% | 113.1% | n/a | n/a | n/a | 2 | 4 |
A Few More Patient Alternatives
AGF American Growth (US Equity)
Lead manager Steve Rogers holds a simple belief that as earnings go, so do stock prices. Rogers has run this flagship fund since 1994 and looks for big cap US market leaders with strong growth in both revenues and profits. While there is a limit to what he'll pay for a company, valuation is a secondary consideration for Rogers. His focus on larger companies and his lack of an analyst team means he relies strictly on street research. He believes that he gets good quality research since all of his stocks are very well followed by several analysts. Rogers typically holds 35 to 40 names and stays fully invested. His target holding period is 5 years, but has averaged about half of that in recent years. Average turnover since Rogers took over has been about 50% per year but that is slowing and is expected to settle into the 35% to 40% range - very low for US equity managers.
Since 1994, Rogers has kept this fund ahead of its peers and the S&P 500 index - an enviable feat. Most of his success has come over the past two years, during which his top holdings have been peppered with big tech stocks. The large tech component remains and is currently over 40% of the portfolio. Though the fund shuns pricey concept stocks, the tech core presents a bit of risk due to high valuations. Rogers' top four holdings (Cisco, Microsoft, Intel, and Dell make up 27% of the portfolio) are currently trading at an average of 85 times last year's earnings and 90 times last year's cash flows. Cisco, the top holding, is trading at a stock price equal to 151 times last year's cash flows. Over the last five years, Cisco has grown profits by 31% annually, but they'll need to sustain that type of performance for the next ten years just to deliver respectable returns to shareholders. Apparently Rogers thinks it will happen but therein lies the risk with Cisco, and many of his top holdings - if they have one bad year the stock price will get pounded.
Though it may not be apparent from some of my comments, I like this fund. It is one of the best and few lower turnover US stock funds available. But high fees and big positions in tech may present a significant risk at this time. Otherwise, this is a great long-term hold - especially for those looking for a true buy-and-hold approach. But if technology scares you right now, take a look at AIC Value fund. It's a good US stock fund with little in tech but a big exposure to financials and very low turnover.
C.I. Harbour (Mid-large cap Canadian equity)
Often categorized as a value manager, Gerry Coleman is more accurately described as a value-conscious growth manager. He holds a tight number of stocks in this portfolio, which he admits is an eclectic mix of Canadian corporate names. Coleman continues to see great opportunities in Canada's more traditional businesses like Alcan, Stelco, Talisman Energy, and Royal Bank. He still sees great values in smaller companies, as a group, but has generally had difficulty in finding companies of any size that possess good growth prospects and represent good value. As a result, cash was around 20% for most of 1999, but that's been reduced to under 14% by mid 2000. Performance hasn't been impressive next to this fund's tech-heavy peer group, which knocked the Harbour fund into the third quartile at the end of June. As of May 31, 2000 Coleman had brought the fund to first quartile performance on a year-to-date basis. But June saw Nortel pull up the key large cap indices (along with many funds) to leave the fund below average for the first half of 2000. Why the performance lag? Coleman simply hasn't owned either BCE or Nortel, which pretty much explains the gap. But good things await for patient unitholders of this fund, which is filled with cheap growth companies with sound businesses. Since this large cap fund is absent high tech, a good strategy would be to pair this up with a small cap fund that is likely to catch the high tech wave - like Trimark Enterprise Small Cap (managed by Lynn Miller of C.A. Delaney Capital Management) or Signature Explorer (formerly the BPI Canadian Small Companies fund, managed by Steven Misener).
CIBC US Equity Index (US equity)
Indexing is at the centre of heated debate right now, especially in markets like Canada and Finland where index levels are at the mercy of a single stock. While most investors still seek out active managers capable of outperforming a passive index, it's tough to argue against indexing in the stock market with the greatest liquidity and pricing efficiency - the United States. No matter how you look at this issue, indexing in the US is a compelling strategy. This fund is the only one that tracks the Wilshire 5000 index. The Wilshire 5000 is known as a total market index because the 7,000 constituent stocks cover the entire spectrum of large, mid, and small cap stocks. Like any index, it's still large cap heavy (~ 70% compared to over 80% for the S&P 500) but this provides index investors with better diversification if a passive strategy is what you want. But a passive strategy is still best paired with a great actively managed small cap fund such as Universal US Emerging Growth or AGF Aggressive Growth (both more aggressive high turnover funds).
Universal Future (Mid-large cap Canadian equity/technology)
John Rohr is modest in saying that he's not a technology expert (though many would disagree) but he's done wonders with this portfolio. The core of this portfolio (50% to 60%) is invested in technology companies. But this is not your average tech fund. It is unique because it was the first fund to focus on Canadian technology. Also, Rohr controls risk in this volatile sector in four ways.
First, Rohr's definition of technology is much broader than the typical tech fund. He's not buying e-commerce and Internet stocks, but he's hot on two key themes when it comes to the Internet - infrastructure and b2b - choosing to focus on firms with a strong revenue base today and generating actual cash flows. Second, although he focusses on such a high growth sector, he is more sensitive to valuations than just about any other tech manager on the street. That led him to hold more cash late last year, which had him well positioned to whether the spring tech meltdown and pick up some relative bargains. Third, risk is controlled by not having individual stocks make up more than about 5% to 6% of the total portfolio. Rohr bought JDS years ago and let it run up to 7.5% of the portfolio because he just loved the company and the way they had managed their explosive growth. But in March of 2000 he cut the fund's position down to about 4% for valuation and risk reasons. Finally, about 20% of the portfolio is kept in energy stocks as a hedge against the high tech core and 22% of the fund currently sits in cash.
Many investors are still hungry for tech exposure, but excessively high valuations makes this a risky time to load up on the sector. For those anxious to hop on the tech bandwagon, this fund is ideal - with its tech core and many risk controls.
Standard Life Canadian Dividend (Large cap Canadian equity)
Run by Standard's Montreal-based team, this fund is really a Canadian stock fund since it holds only common stocks - no preferreds like income oriented dividend funds. So the relative performance figures you see in table II are against other large cap Canadian stock funds. Standard Life uses virtually no street research, choosing rather to generate all of their information from their in-house team of 14 analysts, each specializing in a couple of industries. This portfolio's objective of generating a lot of dividend income gives it a natural bias towards financials (and banks in particular), which typically pay above average dividends and historically have shown good growth in dividends. So while the heavy bank component (currently ~ 45%) makes this fund more vulnerable to rate hikes, its above average dividend yield (2.4% vs. 1.0%) gives it a little extra cushion in the event of a widespread decline. Fees are dirt cheap at just 1.5% annually and the list of names is kept to about 25 to 30 in total, giving the portfolio good diversification and a true focus on large cap stocks.
Performance has been great for this conservative offering. The mid-1990s love affair with bank stocks paid off handsomely for this fund. Now, banks are more value plays than they've been in years, which gives this fund two key benefits: lower downside (due to low prices and high yields) and better upside potential (due to strong fundamentals). Just make sure to use this fund prudently. If you've got financial funds or other holdings heavy in financial services, don't buy this fund. This is a great match to a small cap growth fund or a fund that tends to have a tech focus.
Table II: True Buy-and-Hold Funds
| Fund Name | 1998 Turnover | 1999 Turnover | 1996 Quartile | 1997 Quartile | 1998 Quartile | 1999 Quartile | Jun 2000 Quartile |
| AGF Amer Grth* | 40.4% | 44.7% | 1 | 3 | 1 | 1 | 2 |
| AIC Value*** | 79.2% | 6.6% | 1 | 1 | 3 | 4 | 1 |
| C.I. Harbour | 31.5% | 22.6% | n/a | n/a | 1 | 3 | 3 |
| CIBC US Eq Index | 17.4% | 27.8% | n/a | n/a | 2 | 2 | 2 |
| Universal Future** | 11.5% | 19.7% | 4 | 2 | 1 | 1 | 1 |
| Standard Life Cdn Dividend | 30.1% | 27.6% | 1 | 1 | 1 | 3 | 2 |
In Summary
Turnover is important for two reasons. First, it results in increased costs. Those higher costs create a higher "hurdle" that active managers must leap in order to justify their fees and add value, in relation to other passive and active alternatives. (It should be noted that many other high turnover funds exist. But since this information must be manually searched, the list of heavy traders will unintentionally overlook other culprits.) Second, if you are striving to build your portfolio's core with buy-and-hold funds, it only stands to reason that the funds you hold should have something in common with that philosophy.
That said, there are some terrific funds (many of those mentioned above) that do trade quite actively. While there is absolutely nothing wrong with such funds, it can be misleading when a fund gives the impression of a buy-and-hold portfolio by its name and/or the description of its style or objectives. That's when investor awareness must be raised to make sure you know what you're buying.
Dan Hallett, B.Comm., CFP is Senior Analyst with Sterling Mutuals Inc. Dan can be reached by e-mail at dhallett@sterlingmutuals.com Information on specific mutual funds was obtained from fund annual reports, regulatory filings, and manager interviews. Stock information was obtained from publicly available sources such as www.yahoo.com and www.smartmoney.com