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Funds take flight on China's economy

Top three funds ride commodity prices

INVESTMENT REPORTER

If a butterfly flaps its wings in China, it can influence events halfway around the world.

That metaphor certainly held true for the top mutual funds in Canada in 2003, many of which owe their lofty returns to a Chinese economy that's taking flight.

Front Street Special Opportunities Canadian Fund, Dynamic Power Hedge Fund and Dynamic Global Resource Fund finished first, second and third, respectively, in a survey of funds with assets of at least $20-million (excluding labour-sponsored, segregated and U.S.-dollar versions of funds).

All three top funds saw their bets on natural resource stocks rewarded as booming demand from China sent commodity prices soaring.

"The Far East is clearly a driving force in the world economy," says Gary Selke, president of Front Street Capital, whose top-performing fund returned a sizzling 121.2 per cent in 2003. "It's a theme that's going to be present throughout the balance of the decade." But as China was spreading its wings, the U.S. dollar was falling out of the sky.

As a result, funds that invested in U.S. and other foreign assets but reported in Canadian dollars were among the worst performers last year, as their returns were slashed by the soaring loonie.

That was the case for the AIC American Balanced Fund, down 11.1 per cent, and the Clarica Global Bond Fund, off 9.6 per cent -- the second- and third-worst performers, respectively. Topping the list of losers was AGF Managed Futures Fund, a high-risk fund that invests in futures contracts linked to various commodities.

The $34.7-million Front Street fund picked an ideal time to load up on energy and metals shares such as Savanna Energy Services Corp., Midnight Oil & Gas Ltd., Wolfden Resources Inc. and LionOre Mining International Ltd.

Managed by Norm Lamarche, the fund uses a top-down approach to identify promising sectors, focusing on small-capitalization stocks with seasoned management. It also looks for special situations such as mergers and acquisitions, liquidations, spin-offs and undervalued companies.

Not all of Mr. Lamarche's picks were resource plays. Take Coretec Inc., a Toronto-based manufacturer of printed circuit boards. The company had fallen out of favour with investors, despite having solid management and little debt. After the fund bought in last summer at less than $1 a share, the stock more than tripled.

With the global economic outlook brightening, Mr. Lamarche sees plenty of opportunities on the horizon. "We're in a growth part of the economic phase here, and I think it's going to be an exciting place for small caps generally speaking."

It was a similar story for the $55.7-million Dynamic Power Hedge Fund, which returned 101.5 per cent thanks to its heavy exposure to companies involved in exploration and production of nickel, copper, gold, oil and gas. Its holdings last year included First Quantum Minerals Ltd., Kensington Resources Ltd., Dynatec Corp. and Ivanhoe Mines Ltd.

"We were focusing on emerging companies because we believed that's where you were going to get the big bang," says manager Rohit Sehgal. He predicts demand for natural resources will remain strong and recently increased the fund's exposure to energy shares.

Because it is a hedge fund, he has the ability to sell short if he believes a stock is poised to fall in price. But with markets rising sharply last year, the fund didn't use that option. "Given the environment we were in, shorting was a hazardous thing to do," he says.

This year could be different, however. With some technology stocks trading at sky-high valuations, "we're watching that area very closely. We'll probably have some [short-selling] opportunities," he says, although he declines to name potential targets.

Dynamic claimed third spot as well, posting a 93.8-per-cent return for its $21.7-million Dynamic Global Resource Fund. As of Nov. 28, the fund's top holdings included Canico Resource Corp., Alcan Inc., Ivanhoe Mines and First Quantum, all of which benefited from surging commodity prices.

But commodities can be a double-edged sword, as the year's worst-performing fund -- AGF Managed Futures -- discovered.

The volatile fund, which trades futures contracts on a range of commodities -- such as natural gas, cattle, gold, coffee, oil and corn -- plunged 41.8 per cent in 2003.

AGF spokeswoman Tanis Robinson says the $21.7-million fund actively trades long and short positions to capitalize on trends in commodity prices. The fund is "suitable only for investors with a high tolerance for risk and should form only a small portion of a diversified portfolio," she says.

Underlining its volatility, the fund posted a positive return through the first three quarters of 2003, then sank into negative territory because of swings in natural gas prices and a period of limited liquidity in the market, she says. As of Jan. 29, it was up 17 per cent in 2004.

Currencies were also a huge source of volatility last year -- especially for funds that invested in U.S. stocks and bonds.

The $25.2-million AIC American Balanced Fund posted the second-worst record, falling 11.1 per cent, as the Canadian dollar's 22-per-cent rise against the U.S. dollar more than wiped out gains on the fund's portfolio of U.S. blue-chip stocks and U.S.-dollar-denominated bonds.

"By far the biggest question I get these days is not about our philosophy or holdings, it's about the U.S. dollar," says Michele Calpin, co-manager of the fund. Stripping out the currency swings, "it's a conservative, steady and sure fund," she says.

The loonie's surge was also bad news for the $61.9-million Clarica Global Bond Fund, which was down 9.6 per cent. The fund aims to provide foreign-currency diversification while remaining 100-per-cent eligible for registered retirement savings plans. It does this by investing in foreign-currency bonds issued by Canadian governments, international agencies and foreign governments.

"We did partially hedge the portfolio back into Canadian dollars during the year. However, the significant increase in the dollar versus many other currencies still hurt performance," says William Sterling, chief investment officer with Trilogy Advisors, which manages the fund. Mr. Sterling expects the U.S. dollar to continue to weaken.

Best and worst performers in 2003

Ranked by one-year returns to Dec. 31. Funds with assets over $20-million; excludes U.S.-dollar-equivalent funds and Canadian, U.S. money-market funds.

Top 15 funds

Fund...Assets ($'000)...One-year return...Three-year return*

Front Street Special Opp Canadian...$34,669...+121.2%...+37.8%

Dynamic Power Hedge Fund...55,697...+101.5...--

Dynamic Global Resource...21,666...+93.8...+28.5

King & Victoria Fund LP...22,200...+88.4...--

Excel India...21,160...+82.9...+8.7

Northern Rivers Innovation Fund LP...21,800...+75.2...--

Sprott Gold and Precious Minerals...335,888...+72.4...--

Dynamic Global Precious Metals...43,918...+71.7...+59.1

Martime Life Cdn Growth-R...126,452...+69.8...+26.2

Martime Life Cdn Small Cap-B...20,751...+68.7...--

Martime Life Cdn Small Cap A&C...37,678...+68.7...--

Dynamic Power Small Cap...161,459...+67.9...+9.6

Acuity All Cap 30 Canadian Equity...29,134...+67.2...+20.8

Altamira Precious & Strategic Metal...77,203...+67.1...+53.9

Sceptre Equity Growth...230,023...+66.7...+25.1

Bottom 15 funds

AGF Managed Futures...$21,729...-41.8%...-26.5%

Triax Growth-I**...94,695...-25.0...-30.9

VentureLink Fund Series I**...29,010...-19.5...--

B.E.S.T. Discovered**...52,830...-18.9...-19.0

Canadian Science & Tech Growth**...62,346...-17.6...-15.2

New Millennium Venture**...46,624...-13.6...-13.6

AIC American Balanced...25,234...-11.1...-7.2

Clarica SF Global Bond...29,432...-9.8...+2.9

Clarica Global Bond...61,866...-9.6...+3.1

Covington Fund I**...100,137...-9.0...-17.4

Standard Life Int'l Bond RSP-A...29,935...-8.9...+4.8

VenGrowth II Investment Fund Inc.**...487,401...-8.3...-4.5

Canada Life Flex Int'l Bond (Lake)...43,136...-8.0...+3.2

Canada Life Gens Int'l Bond (Lake)...43,136...-8.0...+3.2

Mackenzie Sen Tactical Global Bond...53,592...-7.7...+3.2

-*Average annual return

-**Labour-sponsored funds

SOURCE: GLOBE HYSALES

© 2007 The Globe and Mail. All rights reserved.

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