Canadian investors have come a long way over the decade since they began investing, big-time, in mutual funds. Against a backdrop of falling interest rates, they moved mounds of money into those grand pools of stock-buying power, many of which were held in registered retirement savings plans. Today, the mutual fund industry in Canada manages approximately $540 billion in assets, up from $59 billion in 1992, and the industry’s leaders calculate that 80 to 85 per cent of Canadians who can afford them own units. What’s striking, though, is the amount of confusion and plain old lack of understanding surrounding mutual funds. Canadians may have come a long way in their enthusiastic embrace of the product, but with many investors expecting their holdings to support them in retirement, they still have lots to learn.
This became brutally apparent in 2000. As markets teetered and tottered, dreams of double-your-money returns were dashed, and fortunes, at least of the paper variety, foundered. In the words of industry spokesman Tom Hockin, last year was a “reality check.” What was hot in January definitely was not in December, as best illustrated by the rudely abrupt close to a spectacular three-year run by science and technology funds. “The year was almost a graduate course in the electric shock that you can get from the market,” says Hockin, president of the Investment Funds Institute of Canada (IFIC).
It was just a year ago that tech stocks were still in a supposedly endless climbing mode, the economy on both sides of the border was booming, and the discussion among many experts—too many—was not about when the end would come but whether the world had entered a new phase of eternal growth in defiance of past boom and bust cycles. Then, last spring, technology stocks hit the first dramatic dip in what turned out to be a true roller-coaster ride, as measured by the Nasdaq composite index—up 16 per cent in February, an all-time high on March 10, then down nine per cent in April and another 14 in May, back up 11 in June, down six in July and up 14 again in August. And through the autumn, the Nasdaq was a disaster: down, down, down every month to close the year worth 40-per-cent less than at the beginning. The broader equities market, as measured in Canada by the Toronto Stock Exchange 300 composite index, took its lumps a bit later in the game—and they were not so dramatic. Other than slight dips in April and May, the TSE 300 showed positive growth until September, when it dropped 7.6 per cent and, under the influence of tech in general and Nortel Networks Corp. in particular, continued falling until its slight 1.3-per-cent bounce in December. Still, over the year, the index showed a 7.4-per-cent gain.
In a market marked by volatility, there were some pleasant surprises. At the beginning of 2000, who would have thought that the languishing stock prices of banks and other financial firms would shoot up and make funds specializing in Canadian financial services the years best-performing subcategory, with average returns for 2000 of 36.6 per cent? That compares with an average loss of 11.9 per cent for science and technology funds for the year. Another highlight was the performance of Canadian stock funds relative to the U.S. version. The average Canadian equity fund, holding stocks with diversified market capitalizations, had a return for the year of 10.1 per cent, while the average U.S. equity fund fell 4.6 per cent.
Of course, as every fund prospectus says, past performance is no guarantee of future returns. Understanding market conditions is critical for investors, but so is the ability to compare a mutual fund’s longer-term performance against that of its peers. This anchors the thinking behind the annual Maclean's fund Dynamic Wealth Management rankings, which are compiled by Morningstar Research Inc., a Toronto-based investment research company owned by Morningstar Inc. of Chicago. The tables offer the best and worst funds in eight selected categories based on three important measures: annual compound return over three years, risk-adjusted return over three years and average annual return in each of the past five years. Just for fun—not advice—there’s also a table showing the winners and losers based only on last year’s performance.
The tables show returns after deducting all management fees (but not sales commissions, if applicable) and are based on total returns, including dividends, to Dec. 31,2000. Funds that have existed for less than three years are not included. The report also includes the Hot 100 mutual funds, an exclusive best-of-class listing based on a more detailed Morningstar rating system that takes into account past performance, volatility and consistency over three years. The funds that scored highest are not always the ones that have earned the highest returns. Instead, they have tended to produce returns significantly above the average on a consistent basis given the amount of risk they took with unitholders’ money.
Longer-term returns often tell a different tale than recent ones. Take those once-manic science and technology funds. While hammered in the second half of the year (losing, on average, 24.9 per cent of their value), they still showed highly respectable three-year returns of 29.2 per cent (that’s a compound annual return), making these funds the best performers over the three-year period. The top sci-tech fund on Maclean's table, Altamira Science & Technology, showed a three-year return of 61.4 per cent, even including its loss of 33.5 per cent in the last six months of 2000. It was also the best three-year performer across all the Maclean's tables.
Investors usually respond to the market’s vagaries after a slight lag, says Earl Bederman, president of Investor Economics Inc., a Toronto-based financial-industry consulting firm that tracks the flow of money in and out of mutual funds. His figures show a slight tilt in favour of more conservative investing towards the end of last year. During the first 10 months of 2000, $5 billion exited Canadian money-market funds— which are little different from bank-account cash—but $1.5 billion went back in November and December. Bederman says people still believe in equities, including tech. In 2000, $11.3 billion flowed into science and technology funds, with $3.4 billion of that coming in the second half of the year. There’s been an attitudinal shift among investors in favour of investing in equities, Bederman says. “They believe in it,” he says. “They’re not off that pitch.”
Ian Ainsworth, named in December by his peers as fund manager of the year for the second year running, is among the believers. Ainsworth is managing director for equities at Toronto-based fund giant Altamira Investment Services Inc., overseeing the Altamira Science and Technology fund, among others. Even though he watched the company’s massive $ 1.6 billion Altamira equity fund lose 14.4 per cent in value in the last three months of 2000, he insists market conditions in the long term are ideal for equities. He expects inflation will stay at a low level, contributing to moderate global growth. The current shakedown, he argues, is simply one that defines the winners and the losers in the marketplace. It would be folly to stay away because, he says, “the fundamentals are too good.”
Partly in response to the reality check that came with last year’s turbulence, investors turned back to mutual funds, probably in a collective tip of the hat to the professional money managers. For the first time since 1997, says the Investment Funds Institute, the amount of new money invested in funds, at $22.8 billion in 2000, was up over the previous year, which rang in sales of $17.7 billion.
It’s believed that much of last year’s boost in fund sales came from investing do-it-yourselfers who were returning to the fold. The terrific buoyancy of the markets in 1999 lured many investors to try their own hand at stock picking. Some didn’t like the management-expense ratios that go with mutual funds. Others thought they’d tap into higher returns by investing directly. Still others wanted to take a more active role in managing their own affairs. For much of 1999, especially in tech stocks, it was hard to go wrong—virtually all the dot-coms were flying. But the end of the tale is already well told, and in many cases it wasn’t pretty.
Steve Burke, a 50-year-old entrepreneur and father of two daughters living in Toronto, is a longtime investor who says he learned the hard way in an earlier recession that investing is best left to the pros. In the late 1970s and early ’80s, he managed his own portfolio, and saw his $250,000 account plummet to less than $100,000. “It was horrible,” Burke says. He now relies on an investment adviser and says his portfolio, worth about $500,000, is 95-per-cent invested in mutual funds.
The lesson Burke learned so many years ago is repeated over and over again. Get an adviser. Make a financial plan. Know what you want and know the level of risk you can tolerate. Understand that high returns mean high risk, which, translated, really means potentially huge losses and many sleepless nights. People shouldn’t hesitate to ask for professional advice, says Brenda Vince, chief operating officer of the Royal Bank of Canada's mutual funds business. “Do you cut your own hair?” she asks. The IFIC s Hockin says people have realized investing is not so easy after all. “It’s humility,” he adds.
For Manon Miliaire, a 39-year-old account manager who saves diligently for her retirement, the humility is augmented by a sense of bewilderment with the mutual fund industry. Canada now has more than 3,300 funds, and the number grows by the day—along with the sophistication and complexity of the products offered. In 1992, the first year BellCharts Inc., one of Morningstar's predecessor companies in Canada, computerized its industry data, there were roughly 500 hands available in Canada, and most of them were of the garden-variety type. Today's offerings are much more fine-tuned: there are sector-specific hands— precious metals, for instance; there are funds defined by the type of holding, such as dividend hands; there are large cap and small cap hands, reflecting capitalization; and there are equity hands, high-yield bond funds and balanced funds, the last a mix of the previous two. There are hands focused on regions of the world combined with types of holdings—for instance, Indian equity funds, which was Morningstar's worst-ranked subgroup. And then there are clone hands, a recent innovation that’s proving highly popular. These allow Canadians the benefits of investing outside Canada while still respecting the limits set by Ottawa on foreign investment eligibility for RRSPs (which rose to 30 per cent on Jan. 1).
The success of the mutual fund industry has spawned mimics: insurance companies now offer segregated funds, which look like mutual funds but are wrapped around insurance policies. Popular for their inexpensive fees are the exchange-traded funds (page 44), which track market indexes. Miliaire says she’s not interested in deciphering the industry. “I call my broker,” she says. “I tell him, ‘You know how I am. I am insecure. So play with my money as long as I get some returns with it.’ ”
Miliaire, despite her disinterest, has nailed one of the key lessons of investing—she knows what she needs to feel comfortable. By telling her broker she is insecure, she’s telling him she is a conservative investor. He’s then obliged to invest her money cautiously, and avoid volatile sectors and regions. Many people take a lot of time to find out about stocks, says Ed Legzdins, president and CEO of BMO Mutual Funds. “But what they really need is to find out more about themselves.”
One way to do that is with a financial planner. Hockin says even he finally called a planner two years ago. Among a myriad of questions about his assets, debts and obligations, the planner asked Hockin if his two daughters were married. Had he made provision for that, she wanted to know. Based on an investor’s age, obligations and income, a planner can help determine one’s level of risk tolerance. The next step is to look at a fund’s past returns—plus its cost and its holdings. “There’s more to evaluating a fund than just looking at performance,” says Scott Mackenzie, president of Morningstar Research. Investors, he says, should ensure that the fund they’re investing in contains the assets they want. The other important element is the allocation mix of the investor’s portfolio. A player who has a low tolerance for risk still might hold some risky technology stocks, the experts say, as long as it is a small portion of his or her portfolio and is buffered by safer, more stable holdings, such as money-market funds.
Before investors begin to figure out the best mix, they need to bone up on some of the basics. What do the different types of funds mean? How much risk is associated with each one? For much of the investing public, these are still mysteries. An Ipsos Reid survey conducted last November for the Royal Bank found that 40 per cent of Canadian mutual fund holders didn’t know what type of 1/1 fund they hold. While more than half of the Canadians polled (all adults, with the study weighted to mirror the census) planned to contribute to an RRSP for the 2000 taxation year and many of them intend to put their money in a mutual fund, 40 per cent also didn’t know what type of fund to buy. “They’re probably embarrassed,” says the Royal’s Vince. “They can be very sophisticated people.”
One reason for the lack of understanding about investments is that a whole generation grew up believing their retirement years would be provided for, Hockin says. “We’ve gone from a dependence on the employer and the state to a do-it-yourself society,” he says. “We’re just at that time in history where the shift is occurring.”
If investors are lucky, the markets will be less rocky, more gentle this year. And maybe that steep learning curve will smooth out a bit, too.
With Brenda Branswell in Montreal