Dangers of the Herd Mentality

Diane Forrest January 31 2000

Dangers of the Herd Mentality

Diane Forrest January 31 2000

Dangers of the Herd Mentality


A fashionable new fund can be

a useful part of a portfolio—but all too often results m the same old story of investors chasing last year’s returns

Diane Forrest

Lemmings do not deserve their reputations for running off cliffs and into the ocean in a panic-stricken herd. Humans, on the other hand, are well-known to suffer from sudden irrational behaviour—especially around RRSP time, when they catch the scent of an exciting new kind of mutual fund. “Every year, the fund companies bring out the new flavour,” says Mike Berton of IFC Planning Group Inc. in Vancouver. And for a financial planner like Berton, it’s difficult to persuade clients not to plunge their entire RRSP contribution into a new category of fund simply because it is highly touted and sounds ideal for current economic conditions.

Often the fashionable new fund can be a useful part of a portfolio. For example, the new foreign “clone” funds can be

a helpful tool for those who want to maximize the foreign content in their retirement savings plans. Under current rules, Canadians cannot invest more than 20 per cent of their RRSPs outside Canada. Clone funds do not actually invest in foreign stocks, but use derivatives to duplicate the performance of regular foreign funds, so they count as Canadian rather than foreign investments. Another class of funds that is proving popular are the new Internet-inspired funds such as Altamiras E-Business Fund and AIM Global Technology Fund, both of which boast a year of stunning returns. “You have to give the industry credit for invention,” says John Kaszel, director of research at the Investment Funds Institute of Canada. “If we stayed the same, wed still have the vanilla funds we had in the ’70s—equity, bonds, money markets and perhaps a mortgage fund. As investors become more sophisticated, they want products that serve specific needs.”

The trouble is the appearance of a fresh, new type of Find all too oFen turns into the same old story of investors chasing last year’s returns. Indeed, Corp., a financial research firm in Windsor, Ont., says that Find investors have a singular giF for buying into a particular cate-

The best way to deal with the

confusing plethora of choices is to develop an investment plan and stick to it

gory at the wrong time. A fund’s published returns—the ones advertised in newspapers and magazines—are based on its results in a specified period. But in real life, investors buy in and sell out all the time, so their results usually differ. The researchers at found that more than 80 per cent of investors who bought resource funds—and close to 90 per cent in the case of precious metals funds—earned less than the funds’ stated returns simply because of when they bought. Not surprisingly, companies tend to promote funds after they report big gains. looked at three-year returns that appeared in fund company ads and compared them with the returns in the three subsequent years. In 92 per cent of the cases, the returns dropped.

The 2000 RRSP season could see the same kind of missteps. Investors have been dumping domestic equity funds and buying up clones at the very time that Canadian markets seem poised to outperform the world. Similarly, Berton is having trouble discouraging his clients from leaping into technology funds. The run-of-the-mill Canadian equity fund certainly looks unattractive, as it continues to trail the Toronto Stock Exchange 300 index. But the TSE is a misleading benchmark, says Berton. The outlandish success of a few high-tech companies—Nortel Networks, BCE Inc. and JDS Uniphase in particular—has distorted the TSE index. Managers of equity funds, however, cannot bet the farm on a few tech companies, says Berton. If the long-expected correction in tech stocks ever happens, he adds, investors will be grateful to those “underperforming” managers.

Like many others in the financial services industry, Berton questions whether mutual fund companies really have investors’ interests at heart as they churn out an increasingly

confusing array of funds. It’s not investors demanding all that choice, says Colin Deane, a consultant with the national accounting firm Ernst & Young who follows the fund industry. “There’s so much product out there, companies are trying to find something to make them stand out,” he says.

Eric Kirzner, an investment expert who teaches at the Rotman School of Management at the Uni¡ versity of Toronto, believes the proliferation of I funds encourages investor stampedes. “Investors I worry that they’re missing out on something,” he I says. “They see science and technology funds, I high-tech funds, e-commerce funds—it’s just endless, the number of categories.” Kirzner worries that investors will be tempted by the hype to forget their long-term plans and buy a little of each. “The danger is not that you might choose wrong,” Kirzner says, “but that you might end up with a portfolio that doesn’t make sense.” Even the traditionally conservative Templeton Management Ltd. has succumbed to the temptation to develop new products, introducing several new funds in the past year and a half. Still, it has only 18 funds, “a very small number,” points out Tim Hague, vice-president of marketing at Templeton. Partly, that is because the company is concerned about the fallout from the constant introduction of funds. Mutual funds were originally intended to offer a simple alternative to the stock market, yet now there are almost as many funds in Canada as there are stocks on the TSE. “It has the potential to lead to a certain amount of cynicism,” says Hague, “the belief that fund companies are just throwing everything against the wall and seeing what sticks.”

C. I. Mutual Funds ofToronto, one of the country’s fastestgrowing fund companies, trumpets in its ads that it has more than 100 funds. In reality, many are different versions of the same fund; in all, the company offers 38 distinct portfolios. Some were acquired through its merger last July with BPI Financial Corp. and are due for consolidation this summer. But the company plans to bring out a European fund and a global managers fund soon. “Our whole game plan is to provide investors with choice,” says president Peter Anderson.

Anderson agrees that some may find the plethora of choice confusing, but points out a fairly obvious solution: get a financial adviser, develop an investment plan and stick to it. If clients are keen on putting money into new products, Berton says, “we do it with caution. We don’t put more than five per cent in.” He makes sure clients look not just at compound returns, but at annual returns, so they understand what kind of a ride they will be in for. While even the most disastrous buy may make a comeback eventually, “I show them how long it can take to make some money. Three years is a long time to be naked and afraid.” And wondering if the lemmings are laughing. E23