While "gold," "China" and "income trust" were the words investors most wanted to see on their mutual fund statements in 2003, look for "venture capital," "broader Asia" and "the resurgence of conservatism" to become the watchwords of 2004, experts predict.
This year should also see investors pump money back into the coffers of Canadian mutual fund companies, many believe.
That forecast should offer relief to an industry that has watched a net $1.7-billion flow out of Canadian funds in 2003. Small investors, rattled by a 2½-year bear market in North American stocks, refused to put up more cash no matter how high equity markets soared. Meanwhile, burgeoning scandals at marquee mutual fund companies in the United States threatened to unnerve Canadians even more.
Duncan Stewart, a partner at Tera Capital and manager of the $94.7-million Dynamic Canadian Technology fund, says many Canadian mutual fund investors are still oblivious to 2003's strong recovery in stock markets.
His fund surged 38 per cent in 2003.
"The remarkable thing is that almost none of my clients know it."
Mr. Stewart is becoming accustomed to people offering condolences instead of congratulations. He thinks that many investors became so disheartened by the bear stretching from 2000 into early 2003 that they no longer followed the markets.
"People stopped looking at their statements. It just became too painful."
Mr. Stewart calls 2003's rally a stealth bull market.
Canadian equity funds, including his own, are not seeing new money come in yet.
He says many investors think that any upturn in the markets is "just another head-fake."
He points to early 1992 and 1993, when investors were leery after the hard times of the previous years.
"People just didn't want to hear the story. But they will."
When small investors do start paying attention, Mr. Stewart says, markets could well have another leg up as new money comes off the sidelines and into stocks.
Dan Hallett, president of Dan Hallett & Associates Inc. in Windsor, Ont., says one could argue that net outflows from stock funds in the past 18 months or so are simply part of a healthy rebalancing after the "all stocks all the time" attitude that many investors adopted in the late 1990s.
Of late, Canadians have favoured income trusts, bonds and dividend-paying stocks. In the first 11 months of 2003, investors poured a net $3.5-billion, combined, into those categories.
Mr. Hallett believes investors are continuing their old habit of chasing performance.
"The industry is really at the mercy of the markets."
Among Canadian equity fund managers, those who favour growth ran pretty much neck-and-neck with the value-style managers in 2003.
Through the end of November, growth funds had advanced 19.1 per cent, while value funds posted a 22.6-per-cent gain.
Mr. Hallett tends to favour value-style investing for the long term, and he thinks value managers will do well this year.
He also believes venture capital and labour-sponsored investment funds could see a return to favour in the next year or two after being ignored for the past few years.
Valuations in the private equity area have been sliding steadily since the end of the technology boom, he says. Even as publicly traded equities have rebounded, private equities have not.
"There's been a lid on valuations."
However, Mr. Hallett warns, it's difficult to predict when labour-sponsored funds that invest in tiny companies will take off.
"I don't know when the payoff will come."
Mr. Hallett also believes China's rapacious industrial growth and demand for commodities will continue to be big stories.
"You don't want to have too heavy an allocation there because it's a volatile area."
Mr. Hallett thinks 2004 will see a return to better times for the mutual fund industry, though he acknowledges that wrongdoings surrounding unfair trading practices south of the border could make investors here more wary -- especially if more big names are implicated.
Mr. Hallett does not believe that late trading, where big clients were allowed to place trades after the official close, takes place in Canada.
But he believes that the scandal in the United States could harm the industry here if it deepens or drags on too long.
"It certainly could get worse. It's a huge industry in the U.S."
Scott Barlow, an analyst at CIBC World Markets Inc. in Toronto, notes that the weakening U.S. dollar put a new twist on mutual fund investing in 2003.
"A really big change for fund managers was that the U.S. dollar made everyone think much more regionally."
Rather than thinking about sectors, he explains, managers began to think about regions, such as China and Europe, which saw their currencies climb against the greenback.
As for individual investors, Mr. Barlow says the reluctance to shift away from income trusts likely stems from the fact that they continued to perform well.
As of mid-December, the Scotia Capital income trust index was up almost 19 per cent in 2003.
"It's hard to give up a habit -- especially when it works," he said.
Precious metals funds gained an eye-popping 77 per cent, on average, in the 12 months ended Nov. 30. Mr. Barlow says China's economic boom was the reason for much of the rise in materials.
"It's not so much global as it is one country."
Equity funds that invest in China have also posted stellar returns: The $67.4-million AGF China Focus Class Fund has soared 63 per cent in 2003, for example, and the $56.8-million Talvest China Plus Fund has gained 40 per cent.
Looking ahead, Mr. Barlow recommends investors gain exposure to China by investing in other countries in the region. Many other markets, including South Korea, Taiwan and Thailand, are selling loads of components, commodities and consumer goods to China.
"The economic growth is very, very real," Mr. Barlow said.
But while China's infrastructure building is continuing apace, he says, the country's accounting, regulations and financial systems are not up to the standards of highly developed countries.
Meanwhile, other Asian economies have reformed their financial systems since the crisis of 1998.
He also finds that investors are becoming more interested in Europe. He notes that Germany's DAX index was the top-performing stock index among the Group of Seven largest industrialized countries with a 37-per-cent advance last year.
Mr. Barlow cautions that Europe's exports will become less competitive as the euro gains strength against the U.S. dollar, but he continues to think that the region offers interesting opportunities for investors. Some funds, he notes, focus on firms that are less affected by currency fluctuations.
Mr. Barlow predicts investors will see a rotation toward high-quality stocks again in 2004 after risk tolerance climbed in 2003.
He looks to the bond market, where spreads between the high-yield market and U.S. Treasuries have narrowed considerably.
"High-yield spreads are a good proxy for how much risk investors are willing to take."
He says conservative, profitable companies will likely do well.
"For investors, it means lower risk and outperformance -- it's the best of all worlds."
Another favourite among investors was technology, and Mr. Stewart of Tera Capital believes the stocks can continue to make gains.
The tech-laden Nasdaq composite index in the United States soared 50 per cent last year.
Some market watchers are skeptical that stocks have entered a new bull market precisely because tech has done so well: They point out that, historically, the sector that led one bull market does not lead the next.
But Mr. Stewart argues that tech is not leading, it's participating, just as one would expect during an economic rebound and bull market. He points out that precious metals have outperformed tech.
The portfolio manager is also loading up on Canadian tech stocks because he thinks that's where some of the big gains may be.
© 2007 The Globe and Mail. All rights reserved.
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