Patience and reward

Patience and reward

Ross Laver May 31 1999
Patience and reward

Patience and reward

Ross Laver May 31 1999

Patience and reward

Ross Laver

Strange but true: at a time when the economy is strong and retirement planning practically a national obsession,

Canadas mutual fund industry is stuck in low gear, trying desperately to regain the momentum it enjoyed during the boom years of the mid-1990s.

The trouble started last summer when Asia’s financial crisis hammered North American share prices. But while the stock market has recovered most of those losses, fund sales remain in the cellar. In the first four months of 1999, the flow of new money into mutual funds was 45-per-cent lower than in the same period a year earlier. Domestic stock funds, the flagship products at most fund companies and the source of much of the industry’s profits, have been hit especially hard, with yearto-date sales down a stunning 95 per cent.

Anxious to inject some life back into their numbers, some of the country’s biggest fund companies have been playing musical chairs. Trimark, Spectrum United and Dynamic Mutual Funds have all replaced or shuffled some of their key portfolio managers recently. Another high-profile firm, O’Donnell Investment Management Corp., was swallowed by Strategic Value Corp. after being hit with heavy redemptions.

Throughout the industry, managers are weighing new investment strategies to boost returns and win back customers.

One manager who won’t alter course, however, is Don Reed, president and CEO of Templeton Management Ltd., Canada’s sixth-largest fund company with $ 19.8 billion in assets. Reed is an old-fashioned value investor, meaning he and his research team look for companies that are undervalued by some traditional measure, such as price-toearnings ratio. It takes discipline and steady nerves to be a value investor, because by definition you’re investing in companies nobody else likes. Success comes from hanging on long enough for the stock to regain favour, ignoring whatever investment fads come and go in the meantime.

In today’s market, value investors are about as welcome as a bargain hunter in a ritzy jewelry store. That’s because most of the action is in big, solid, blue-chip stocks—examples include Nortel Networks and Toronto Dominion Bank—or gravitydefying growth stocks such as America Online, Yahoo! and Microsoft, which already boast sky-high valuations.

Hence Reed’s dilemma. In the year ending April 30, his firm’s flagship Templeton Growth Fund, Canada’s biggest

mutual fund with $10.8 billion in assets, returned a paltry two per cent. The fund Reed manages, the $6-billion Templeton International Stock Fund, did even worse, generating 0.4 per cent. By comparison, the funds’ average annual compound returns over 10 years were 13.6 per cent and 14 per cent, respectively.

What does Reed intend to do about his funds’ poor performance recently? Not much, as it happens. To gain some insight into the market’s gyrations, the firm’s analysts completed a study earlier this year of global stock trends going back to 1988. They found that value stocks had beaten growth stocks in all but three of the past 11 years. “We wanted to see if we should be doing anything differently, and the conclusion was that we shouldn’t,” Reed says. “I take comfort from those numbers because we don’t think there’s been a change in the way things have been working for the last umpteen years.”

Reed also takes comfort from the fact that, as of March 31, the average stock in his fund was priced at 16 times its 1998 earnings, roughly half the price-earnings multiple for the market as a whole. “I’ve never seen such a wide spread between our portfolio and the market,” says Reed, 54, who joined Templeton in 1989. “That tells me we’re on the right track, because we’re long-term investors and we’d rather buy a stock when it’s cheap and wait for it to turn around.”

The turnaround may have started, because so far this year value stocks have outperformed growth stocks by a comfortable margin. Whether that persists is anyone’s guess, but Reed thinks it’s only a matter of time before the mutual fund industry resumes its rapid growth. He agrees with a recent Ernst & Young prediction that Canadians’ mutual fund holdings will soar to $1.5 trillion by 2008 from today’s $400 billion. “Right now, there’s a sense the boom has ended, but people who think that way are extrapolating from a short-term trend. If we have growth in the markets of 10 per cent a year for the next seven years, that alone is going to take us to $800 billion, without any new contributions. And don’t forget there’s still a lot of money out there in RRSPs that’s invested in short-term instruments. So to get to $1.5 trillion over the next decade, I don’t have any difficulty imagining that.”

The trick in value investing is to be patient, to wait for the market’s sentiment to turn. It’s worked for Reed in the past, and he’s not about to change his approach now.