A mutual interest

Canadians are buying investment funds at a record rate

October 11 1993

A mutual interest

Canadians are buying investment funds at a record rate

October 11 1993

A mutual interest

Canadians are buying investment funds at a record rate

The spidery writing on the notepaper gave away the letter writer’s age. The Calgary woman wrote the letter to Paul Starita, who, as president of the Royal Trust family of mutual funds, gives investment seminars to thousands of Canadians each year. “I’ve picked up my courage to write to you directly,” the letter said. “I’m now 83 years old and have just over $300,000 in GICs (guaranteed investment certificates) that mature in November and April. My pension was frozen when I left England 10 years ago, so income is important. I don’t want to buy an annuity. Do you think the following three mutual funds would be suitable?” Starita says that the inquiry is typical of the acute interest that Canadians are now showing in mutual funds. And it is not just the elderly or the affluent who are taking that investment route. Even younger people, including some in their 20s, are heeding the experts’ advice that by starting to save earlier, they will have to save less. “At the seminars, I get women with babies in their arms,” says Starita. “I tell the rest of the audience that if the babies cry and they don’t like it, they should leave, because those mothers should be there.”

At the rate that mutual funds are selling right now, it seems that everyone but those babies are buying them. In August alone, mutual fund assets in Canada jumped by almost $7 billion to $95.8 billion, the biggest onemonth increase ever. While most of that jump was due to a rise in the value of the stock and bond investments of the funds, $700 million of

the increase was from new purchases by investors. So far this year, Canadians have spent $3 billion buying mutual funds—an amount equal to the total assets of the industry a decade ago. According to a survey released last week by Toronto-based Marketing Solutions, one out of every four Canadian households owns mutual funds, double the rate of just four years ago.

Several forces have propelled the stampede into mutual funds. The most powerful is the dramatic plunge in interest rates over the past two years, which has slashed the returns on guaranteed investment certificates and gov-

ernment bonds—traditionally the most popular savings vehicles for cautious Canadian investors. At the same time, a growing number of baby

boomers are beginning to get serious about saving for retirement. That focus is reinforced by the

federal government’s policy to encourage individuals to save more for their retirement, rather than rely on government programs alone. In 1989, it began deducting

income taxes from the Old Age Se^ curity payments that Ottawa makes to all Canadians aged 65 and over in an ef^ fort to “claw back” benefits to upper-income earners. In 1991, the government began raising the yearly limit for tax-deductible contri-

butions to Registered Retirement Savings Plans. As well, more and more Canadians are self-employed, or working for small companies with no pension plan.

Yet another factor contributing to the appeal of mutual funds is the increasing focus on global markets and investment opportunities. Through mutual funds, Canadians have the option of investing part of their savings in high-growth offshore markets.

Given those trends, mutual funds—through which individual investors turn over their savings to professional money managers who use that pool of money to buy stocks, bonds or other securities—are in many respects the ideal financial product for the 1990s. They allow small investors

to obtain professional money management at a time when the financial markets are more complex than ever. In addition, mutual funds allow individuals, even those with small amounts of money, to diversify their investments. Says Selwyn Kossuth, president of the Investment Funds Institute of Canada, the trade association that represents mutual fund com-

panies: “They aren’t a way to get rich quick. But if people invest regularly in a balanced mix of funds, according to every study that’s ever been done, in the long run, they’ll beat inflation.”

However, other money managers and financial planners wonder whether there could be a down side in the recent rush to mutual funds. Do the new investors really understand the nature of mutual funds, they ask, and will they stick with the funds—investment theory says they should—even if interest rates rise and knock the stuffing out of the stock and bond markets in the near term? Tom Delaney, a Toronto-based financial adviser and a widely respected expert on RRSPs, says that the funds can be a solid investment, but that consumers should be cautious. “Some people oversell mutual funds and create unrealistic expectations in the minds of inexperienced investors,” says Delaney. “Anything less than a 20-per-cent return is less than expected. Anything less than 10 per cent is devastating.”

He adds that investors who are desperate for short-term returns create volatility in the market by trading fund shares like stocks. De laney also says that with more investors flocking to a handful of popular funds, managers of those funds often find it increasingly difficult to identify profitable new investments.

For his part, however, Philip Armstrong, president of Toronto-based Altamira Investment Services, which operates the fastestgrowing major group of mutual funds in Canada, is more confident about Canadian investors’ grasp of investment issues: “I don’t have the answer. But I do think that the people who buy mutual funds understand more than we sometimes assume.”

Eager to participate in the mutual fund boom, all major Canadian chartered banks

have now introduced their own families of funds. In fact, four of the banks and one trust company now account for five of the nine largest mutual fund managers. They have helped to greatly popularize the product by introducing and promoting the socalled no-load fund. These funds can be purchased directly from the bank rather than through a stockbroker and are free of the sales commission charge—as much as nine per cent in some cases— that is levied on most other mutual fund purchases.

The booming Canadian mutual fund market has also attracted interest from aggressive U.S. funds. Fidelity Investments Canada, which opened its doors in 1988 as a branch of its Boston-based parent, is now the secondfastest-growing fund manager

in the country, with $3.3 billion in assets. Because of the dent that Fidelity has made in the domestic market, with high-profile managers and generous advertising budgets, many Canadian mutual fund companies are beginning to look anxiously over their shoulders. But, says John Vivash, president of CIBC Secu-

rities Inc.: “The biggest challenge for the industry right now is to get over its fear of foreign competition.”

Intense competition is not, however, daunting other new entrants in the market: the number of funds has grown to 602 compared with 517 a year ago. As part of that rush, Robert Swan, a founder of TAL Investments, launched the Clean Environment family of mutual funds two years ago to invest in companies that embody the principles of the socalled New Economy. So far, it has focused on investment in smaller technologically advanced companies that manufacture such environmentally correct products as heat pumps and water filters. Clean Environment now manages about $15 million in mutual fund assets and its common-share fund turned in an impressive return of 44 per cent over the past year. But it al-

so provides a fresh approach for marketing. "The field is very crowded today," explains Swan. "You've got to have something unique to get attention."

As competition and marketing picks up in the Canadian indus

try, it may soon begin to resemble the U.S. market, where there are now more than 1,000 mutual funds. In the United States, individual funds compete fiercely on such things as management fees. Many companies also limit the size of individual funds, arguing that that strategy will deliver above-average returns. Currently, Canadian funds infrequently advertise their annual management fees—which

are often higher than those in the United States. Canadian funds also rarely close a fund to new money. Doing so is hard for a mutual fund company because it earns its revenues from management fees, which are based on a percentage of its assets. The bigger the assets, the bigger the revenue from fees.

In the late 1980s, some observers scoffed at forecasts that predicted that mutual fund assets would increase to $100 billion by the end of this century. But it now appears that that level will be reached this year—seven years ahead of schedule. One of the latest forecasts done by the accounting firm of Ernst & Young last March for the industry predicts the accumulation of total assets of at least $250 billion by the end of the century. Mark Maxwell, a mutual fund analyst at the Toronto investment firm of Gordon Capital Corp., holds an even more bullish view. He forecasts that mutual fund assets will reach $474 billion by 2002, an amount that he predicts will equal almost twice the value of personal deposits at banks.

Still, the momentum of mutual fund growth is far from assured. Increasingly, money managers fear that an upward surge in interest rates might occur as Canada’s economic recovery takes root. That would cause both stock and bond prices to fall and could send investors—many of whom have never held an investment whose principal value has fallen— galloping towards other investment options such as guaranteed investment certificates.

“We try to educate our fund-holders to understand that mutual funds should be seen as long-term investments,” says Altamira’s Armstrong. He adds that his company is now analysing the reactions of its fund-holders when interest rates edged up and the stock market dropped sharply in July. ‘We found that it tended to be the supposedly more sophisticated investor—those using discount brokers—who were the quickest to get out,” Armstrong notes. “The average investor tended to take a long-term view.” Others point to the behavior of mutual fund investors after the 1987 stock market crash. “In December, 1986, mutual fund assets were $17.5 billion,” said Kossuth. “By December, 1987, assets had grown to $20.4 billion. Despite the crash, people didn’t panic and dump their mutual funds.” Still, both of those past plummets were brief and were immediately followed by partial market recoveries.

Clearly, mutual funds and the types of financial products that they invest in, are now swollen with money from investors like the elderly woman who wrote to Starita for advice. She, and others like her, are accustomed to investments that pay a guaranteed annual return and, even more importantly, never fall in value. Their mettle may be tested when the market turns against them, as it surely will someday.