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Mutual Fund News

September bear taught us some lessons

rcarrick@globeandmail.com

Bull markets are preferable all around, but bear markets teach you a lot more about investing.

Oh, the lessons that have been taught this past September, as the S&P/TSX composite index dropped 14.7 per cent and the S&P 500 fell 9.2 per cent. If you invest in mutual funds, you'll want to study them closely.

The first lesson has to do with the always lively clash between those in the investing community who believe in passive index investing and those who believe actively managed funds are better. An often-cited reason for liking active funds: They perform better in down markets.

The experience of September, admittedly only a very limited and non-definitive period of time, is that this belief is inaccurate. Many funds did lose much less than the index, and we'll give them their due shortly. But way too many popular funds from big companies tanked in September for any grandiose claims to be made about the superiority of active funds.

Index funds and exchange-traded funds, or ETFs, hold the same stocks as a particular stock or bond index. This passive approach contrasts with active management, where individual stocks are chosen by professional money managers. At any given moment in time, it's quite likely that a majority of actively managed funds have lagged the returns of their ETF and index fund competitors, but never mind that. What we're interested in right now is down-market behaviour.

The most popular ETF in Canada is the iShares Cdn LargeCap 60 Index Fund, which lost 13.7 per cent in September, according to Globefund.com. Of the top 10 traditional Canadian equity funds as ranked by assets, only three managed better results last month. For the first three quarters of the year, all but one of the Top 10 funds by assets lost more than the iShares Cdn LargeCap 60 Index Fund.

Another Canadian market ETF set an even higher standard for mutual funds. The Claymore Canadian Fundamental Index ETF lost 9.2 per cent in September, which is better than all but four of the Top 50 Canadian equity funds as ranked by assets.

If major stock indexes are falling hard, then it's a given that index funds and ETFs are doing likewise. But don't assume that the teams of smart stock pickers who run your funds have done a better job.

This brings us to another lesson, which is that the funds you loved during the bull market can turn ugly when stocks go sour. This applies not only to volatile sector funds like those in the natural resources area, but also mainstream funds.

An example is TD Canadian Equity, which plunged a rather shocking 20.1 per cent last month. This $3.3-billion fund delivered terrific returns for years by holding a lot of energy and mining stocks, which happened to lead the market decline last month. It also had a big position in Research In Motion, another market idol that stumbled.

Even a cursory glance at TD Canadian Equity's holdings in recent days would have warned you about the risks this fund posed in a severe market downturn. The question is, did you or your investment adviser bother to look and then plan ahead by taking some profits or balancing this fund with something more conservative?

Another lesson of the past month is that the same factors holding a mutual fund back in a bull market may help it withstand a bear market. There are no better examples of this than a pair of funds from Mackenzie Financial, Ivy Canadian and Cundill Canadian Security. While commodity stocks were powering the S&P/TSX composite index and funds like TD Canadian Equity, this pair had minimal exposure.

If you've owned Ivy Canadian or Cundill Canadian Security - their combined assets are $4.5-billion, so lots of people do - then you've probably been frustrated by their weak performance in the past few years. The Cundill fund actually lost 0.4 per cent annually over the two years to Aug. 31, even while the S&P/TSX composite was making 9.6 per cent, including dividends.

Now, redemption seems to be at hand. Cundill Canadian Security fell just 5.8 per cent in September, while Ivy Canadian fund lost 7.3 per cent.

Investors, these funds highlight a question you should be asking yourself the next time you put money in the stock market.

Is it more important to keep up with the highest highs in a bull market, or be protected from the low of lows in a bear market?

*****

How the big boys did in September

Here are the Top 10 Canadian equity mutual funds and exchange-traded funds as ranked by assets, along with their returns for the past month and year to date.

Fund% change in September% change Year-to-date
iShares CDN LargeCap 60 Index Fund-13.7-10.9
RBC Canadian Equity-14.3-14.1
TD Canadian Equity-20.1-17.8
SEI Canadian Equity-O-15.6-15.6
Fidelity True North-B-15.2-15.2
BMO Equity-11.7-11.5
RBC DS Canadian Focus-12.7-13.2
Fidelity Canadian Disciplined Equity-B-15.5-15
Fidelity True North-A-15.2-15.3
PH&N Canadian Equity-A-14.1-15.9

DOUGLAS COULL/THE GLOBE AND MAIL

SOURCE: GLOBEFUND.COM

© 2007 The Globe and Mail. All rights reserved.

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