Funds that
deserve to be ignored
I’ve
devoted a lot of space to ‘buy this fund’ and ‘overweight this sector’ but I’ve
yet to address the funds that should repel you at first glance. Many pay
attention to the ratings of firms like Globefund, Fundata, and Morningstar; and
book authors like Gordon Pape. However, nobody ever talks about the skeletons
in the mutual fund industry’s closet. For various reasons, there are some
investment funds that don’t deserve a place in your portfolio. This week, we
take a look at a few dubious standouts.
If you’ve
read my columns for any length of time, you know that the more conservative the
fund, the more important that fees are in relation to future performance. Bond
and balanced funds bare that rule out beautifully over time. There are always
exceptions in the short term, but if you look at longer-term trends, fees are a
very significant factor.
Trans-Canada
Bond grabs top honours for bond funds to ignore. Its stated management expense
ratio (MER) of 5.19 per cent per year stopped me in my tracks, but that’s as
far as I needed to go to know this fund should be avoided. Interestingly, Sagit
Investment Management, the lead manager of the fund, actually lists its expense
ratio as one of the risk factors of the fund (http://www.sagit.com/fdbond.shtml).
Of all bond funds that have existed throughout the ten years ending January 31,
2002 this fund’s performance ranks dead last, sporting an annualized return of
3.3 per cent over that period. This is not a coincidence.
A large
category of bond funds that investors should think twice about investing in is
segregated bond funds. Recall that segregated funds are investment funds
offered by life insurers and offer some guarantees and the potential for
creditor protection. These extra features, however, come at a price. Using
Morningstar Canada’s database of fund information, the median MER for seg bond
funds is 2.15 per cent per year.
With yields
at historic lows and rates likely to stay flat at best, bond fund MERs are
critical in the selection process.
Investors
Asset Allocation is the largest fund to make this dubious list. Six straight
years of sub-par performance and high fees go hand in hand for this fund. Its
3.23 per cent MER is extremely high for a fund that holds nearly half of its
assets in bonds and cash. To add insult to injury, the fund’s assets are more
than four times what they were six years ago, but the MER hasn’t budged.
Royal
Select Growth Portfolio is a fine example of why I don’t usually take to
fund-of-fund products. One of many reasons is that it’s tough to know what the
asset mix really is. Royal’s website (http://www.royalbank.com/rmf/fundinfo/fund_p/rtgro.html)
implies a 68 per cent equity weighting, while the actual equity exposure is 54
per cent. Their site also says the fund holds just 3% in cash. Technically,
that’s true but it doesn’t count the cash holdings of each individual fund. In
fact, this portfolio of funds holds almost 20 per cent in cash. While I’ll give
Royal credit for dropping this fund’s MER from 2.36 to 2.02 per cent over the
past five years, the performance continues to suffer. Why?
Well, for
starters, there isn’t very good style diversification in this fund. Royal’s
best core Canadian equity fund, Royal Canadian Value, is simply left out of
this portfolio but it would have provided better diversification and better
performance (in my opinion) at a lower cost than the one they chose. Also, the
Royal RSP International Index fund and European Growth funds both have lots of
exposure to large cap European stocks. Not a great match.
For bond
and balanced funds, I basically went by cost but for equity funds my filter for
finding the worst funds was much different. Based on all funds that exist
today, I looked back in time to find the funds with consistently the worst
relative performance. Specifically, I looked at how each fund did compared to
its peers, ranked by quartiles, in each calendar year. (1st quartile
means a fund performed in the top 25 per cent of its group. 4th
quartile funds performed in the bottom 25 per cent of its group.) Funds that
were third or fourth quartile for each of the last six calendar years, were
awarded membership to the hall of shame. Relying on Morningstar Canada’s
database and my first-hand knowledge of mutual fund history, I’ve also done my
best to ensure no meaningful manager changes occurred during the period
studied.
Another
fund managed by Sagit Investment Management makes this dubious list, Cambridge
Growth. Its nearly 5.5 per cent MER notwithstanding, this fund’s record is just
plain ugly. For eight consecutive calendar years, this fund has been beaten by
at least half of its peers (i.e. third or fourth quartile performance each of
those years). The fund’s annualized returns over the past fifteen years and
since its 1966 birth are minus 8.5 per cent and positive 0.7 per cent per year,
respectively.
A fund with
a substantial amount of assets that made the list is the Clarica Canadian
Small/Mid Cap fund. Well-respected Perigee Investment Counsel runs the fund and
its fees are below average, so I actually don’t know what’s behind this fund’s
lack of performance. Even so, its poor record is something to be aware of.
AGF RSP
Equity Allocation is another sizeable fund that makes this list. Lead manager
Steve Way uses a computer model developed by Salomon Smith Barney to pick the
best mix of countries based on valuation, risk, and momentum metrics run on
various countries. However, rather than picking stocks in each country, the
fund uses index futures to simply get index exposure – opting not to even try
adding value by picking good stocks. It sounds good, but the problem is that is
hasn’t worked for many, many years. There will be times when this approach
works well, but I’m not sure that it is worth waiting for when so many other
quality alternatives are available for global equity exposure.
While it’s
difficult to pick tomorrow’s winning funds, it is much easier to toss out the
dogs. To be honest, with more than 4,000 investment funds available for sale, I
can confidently say that fully 90 per cent can be tossed out – still leaving
hundreds of funds from which to choose. That’s a good start to narrowing the
overwhelming universe of investment funds.
Dan Hallett, B.Comm., CFP, CFA is Senior
Investment Analyst with Sterling Mutuals Inc. He can be reached at dhallett@sterlingmutuals.com Sterling Mutuals Inc. is registered as a
mutual fund dealer in Ontario, British Columbia, and Manitoba.