If you want to become a better mutual fund investor, get tough.
Sell your mistakes. Ignore the pull of a fund with a fabulously successful one-year return. And, last but not least, have the guts to buy good funds when they're down.
Successful stock market investors make cold calculations like these all the time, but things are different with funds. Blame it on the fund industry and its propaganda that funds should be bought and held indefinitely, and that any time you have money is a good time to buy funds. More blame goes to the many investors who ask nothing more from a fund they're buying than that it be on a hot streak.
These people have it backwards: The best time to buy funds is when they're on sale, just like with stocks.
As you read on, you'll find some examples of quality funds that present buy-low opportunities as you ready your portfolio for the year ahead. But first, let's consider the sense in buying on the dips as opposed to the peaks.
The key concept here is a bit of investing theory called reversion to the mean, which suggests that fund ups and downs will balance out to returns that approach the middle point. If a fund has done brilliantly in 2004, chances are it will hit a slump at some point that will bring overall returns down.
The converse is true, too. If you buy a fund that has had a below-average year, chances are good that you'll enjoy a compensating period of better-than-average gains.
Don't just buy any struggling fund, though. To stack the odds of a rebound in your favour, focus on funds with solid long-term results that are working through a slump. Good past returns are no guarantee of future success, but a fund that has consistently delivered good performance over 10 years obviously has something going for it.
Buying low suggests a strategy of waiting until a fund hits rock bottom before buying it, but market-timing exercises like this are guesswork. An easier approach is to look at quality funds that haven't been their usual strong selves in 2004.
Screening for funds like these can easily be done on the Globefund.com website. Using the filter function, select an asset class (Canadian equity, for example) and choose the "standard" report. When you get your list of funds, click on the column heading for one-year returns and then click again to order the list from worst performer to best. Next, click on the "quartile ranking" tab at the top of the chart. This will tell you whether a fund has ranked in the first, second, third or fourth quarter of funds in its category on an annual basis in the current year and the previous seven years.
I ran a screen like this for the major fund categories and came up with a few well-established funds that you can buy low right now.
Mackenzie Ivy Canadian, which I've owned for a lot longer than I've been an investment writer, is the definitive example. This $5.2-billion fund has been in the fourth quartile for both 2004 and 2003, which means it has ranked in the bottom 25 per cent of its peers in the Canadian equity fund category. For the 12 months to Nov. 30, its 9.7-per-cent return is a little more than four percentage points below the category average and almost five points below the return of the S&P/TSX 60 index, which I also own through an investment in exchange-traded funds (now you see why actively managed and index funds are a good pairing).
Going on gut instinct, an investor looking for a conservative Canadian equity fund would probably avoid Ivy Canadian because it's clearly in a rut. If you take a long-term view, you might well conclude that this fund's latest numbers are only a temporary setback.
First, its five- and 10-year compound average annual returns are comfortably above average. Second, the fund was in the first quartile four times from 1997 to 2002, a period that includes several bear-market years. If the stock markets were to bog down next year, then Ivy Canadian could be a good way to get some comparatively safe exposure to the equity market. Best of all, it's on sale right now.
The Trimark Fund (SC version) hasn't had the best time of it in 2004, partly because star manager Bill Kanko left and partly because returns have sunk below average. Still, it's another buy-low possibility for 2005.
The bad news with this fund is that the return for the 12 months to Nov. 30 was 2 per cent, while the average fund made 6.2 per cent. The good news is a 20-year history of beating the daylights out of the average foreign equity fund. If Mr. Kanko's departure worries you, just remember that his co-managers remain, and so does the Trimark philosophy of value investing.
A subtler example of a fund on sale is Phillips Hager & North Dividend Income, which beat the average dividend fund return by a percentage point over the past 12 months, but more recently it slipped below the average.
There are times when a good fund's slump is the beginning of a long and painful slide, but this hardly seems likely with PH&N Dividend Income. This is a fund that has demonstrated the consistent ability to outperform the category average by several percentage points over long periods, and there's no one star manager to pin this success on because of PH&N's team approach.
Here are a few other buy-low opportunities.
Saxon High Income. This small fund is a contentious pick as a buy-low opportunity because it lacks the definitive long-term record of success. That said, the five-year average annual return is very close to the category average.
Beutel Goodman Canadian Equity. An interesting choice if you want to invest in big, blue-chip stocks. This fund looked great through the tough market years earlier this decade, and its recent weakness hasn't been too pronounced.
Mackenzie Universal Precious Metals. If you want exposure to gold through a fund with a proven manager, then this entry has to be a serious contender despite subpar results lately. The five- and 10-year returns are well above average.
The byword with buy-low fund investing is patience. It might make take a year or two for a slumping fund to rebound, just as it might take a high-flying fund a while to cool out if you bought it now. The difference with buy-low investing is that the best is yet to come, whereas with buying high you generally have nowhere to go but down.
Bottom fishing
The past year has been a good one for mutual fund investors, but there have been disappointments. Here are a few recent laggards that look good because of their solid long-term records.
| Fund name | Asset class | Net assets ($million) | MER | 1-year return | 1-year category average | 5-year return | 5-year category average | 5-year category average |
| Beutel Goodman Canadian Equity | Canadian equity (Pure) | $290.6 | 1.4% | $10,000 | 15.4% | 16.3% | 11.5% | 6.9% |
| Mackenzie Ivy Canadian | Canadian equity | 5,235.4 | 2.5 | 500 | 9.7 | 13.9 | 6.8 | 6.4 |
| Mackenzie Ivy Enterprise | Canadian equity | 278.0 | 2.5 | 500 | 7.5 | 13,9 | 9.8 | 6.4 |
| Mackenzie Universal Precious Metals | Precious metals | 237.3 | 2.6 | 500 | -17.9 | -15.3 | 27.5 | 21.0 |
| PH&N Dividend Income-A | Canadian dividend | 2,534.8 | 1.2 | 25,000 | 15.1 | 14.2 | 16.7 | 10.6 |
| Saxon High Income | Canadian income trusts | 156.5 | 1.3 | 5,000 | 16.2 | 23.1 | 17.4 | 17.9 |
| Trimark Canadian-SC | Canadian equity | 1,519.3 | 1.6 | 500 | 10.9 | 13.9 | 7.2 | 6.4 |
| Trimark Fund-SC | Global equity | 2,954.7 | 1.6 | 500 | 2.1 | 6.2 | 5.7 | -2.9 |
| Trimark Select Growth | Global equity | 5,342.4 | 2.4 | 500 | 1.5 | 6.2 | 4.9 | -2.9 |
© The Globe and Mail
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