If the mutual fund industry is in a state of critical recovery, it's dividend and income funds that are keeping the patient on life support.
Dividend and income funds -- a broad category that includes high-yield blue chip funds and income trust funds -- continue to capture the lion's share of new money flowing into the sector.
According to the Investment Funds Institute of Canada, the fund class led the industry again in August with net sales of $413.3-million. In contrast, out-of-favour Canadian common share funds saw net redemptions of $248.7-million last month.
The investing trend toward conservative, high-yield funds has an auspicious beginning. At the height of the tech rally in March, 2000, dividend and income funds had about $17.2-billion in assets under management. Today, the sector's assets have nearly tripled to $45.2-billion. Over the same period, investment dollars in Canadian equity funds have climbed a slender 9 per cent to $105.7-billion.
"It speaks to the prevailing conservative sentiment that's been around for four years now," said Rudy Luukko, investment funds editor at Morningstar.ca. "The tech [stock] component in many of these high-yield funds is minimal or in many cases non-existent."
Volatile markets have meant "a fundamental change" in the risk and reward profile of investors, reports David Taylor, manager of six value and dividend funds for Dynamic Mutual Funds Ltd. in Toronto.
"The pleasure of making a dollar in income is probably 10 times better than the pain of losing 50 cents," Mr. Taylor said. "When we speak to clients they say 'If you could just get me 5 per cent a year, I'll be happy. I don't want any more because if I take more, I've got a chance of losing more.' We hear that over and over."
Demographics play a role too, with an aging population keen on saving for retirement, said Marc-André Robitaille, a Montreal-based fund manager who oversees four equity funds for ING Investment Management Inc.
"Baby boomers have a need for income and they are less attracted to growth and more by capital preservation," Mr. Robitaille said.
The high-yield boom has left investors with some daunting choices to make. There are more than 300 dividend funds competing for attention and each month sees a raft of new offerings. Last week, ClaringtonFunds Inc. unveiled a new U.S. dividend fund and RBC Asset Management Inc. introduced two new "fund of funds" portfolios focusing on cash flow.
The investment mix of funds complicates matters further. There is little to differentiate the bulk of dividend funds; many have a whopping 50-per-cent weighting in financial services and double-digit positions in bonds and fixed income products. Duplication is a problem for the income trust sector too, with 85 funds, a group that includes clones and different fund classes, fighting for positions in the best of 144 trusts.
Geoff MacDonald, Toronto-based manager of the Trimark Canadian Endeavour Fund, said strict yield returns can limit stock-picking choices.
"Think about the prospects of only investing in companies that offer only a certain type of yield . . . your universe is much smaller," Mr. MacDonald said. "Over the long term, the more flexibility one has and the bigger one's universe to look for great investments, the better the performance."
Some managers are working hard to differentiate their funds from the rest of the pack. Mr. Taylor's aggressive Dynamic Canadian Dividend Ltd. Fund has a 96-per-cent weighting in stocks. For the 12-month period ended Aug. 31, the fund had a 17.8-per-cent return.
The ING Canadian Dividend Income Fund, meanwhile, has a 55-per-cent weighting in financial services but times its trading around dividend payment dates to maximize returns, Mr. Robitaille said. The fund has a 23.4-per-cent return for the 12-month period ended Aug. 31.
And dividend and income funds are not without risk. Due to their heavy investments in the banking sector, the funds, in general, are interest-rate sensitive. Many funds outperform in a weak equity market but are likely to lag behind in a bull market. In 2003, a surprisingly boffo year for stocks, the average dividend fund reported an 18-per-cent return while the average equity fund was up 20 per cent.
Tom Bradley, president and chief executive officer of Phillips Hager & North Investment Management Ltd. of Vancouver, said the firm's PH&N Dividend and Income Fund has enjoyed a 20-year "tailwind" courtesy of low interest rates, reporting an average annual return of 13.4 per cent.
But rising rates are "one of the risks," Mr. Bradley said. The fund is "not going to plummet but it just may . . . underperform."
That said, no one is predicting investor sentiment will sour any time soon for dividend and income funds.
"There's a very favourable dynamic going forward," said Garth Jestley, president, chief executive officer and fund manager of the Middlefield Group Ltd. The Toronto boutique firm has a fleet of investment trust products, including mutual funds. The Ontario government is considering legislation that will limit the liability of investors in income trusts, a measure that will spark buying by pension funds, he said.
"More and more people are reaching the end of their working careers and are looking to their portfolios to generate income," Mr. Jestley said. "We have a demographic dynamic here that will drive interest in the sector for the foreseeable future."
© 2007 The Globe and Mail. All rights reserved.
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