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Mutual Fund News

Complacency: A major misstep of mutual fund investors

Special to The Globe and Mail

Tom Bradley is president of Steadyhand Investment Funds Inc.

Individual investors (and their advisers) are far too patient when it comes to dealing with changes in their mutual funds. They're quick to make moves based on short-term trends and performance, but slow to recognize the impact of fundamental shifts in personnel or investment approach.

I bring this up because fund mergers and manager changes have become a constant in our industry. In recent weeks, we've seen Trimark change managers on a few of its major funds. Ethical and Northwest Mutual Funds are going ahead with 18 fund mergers. Bank of Nova Scotia is making organizational changes throughout its asset management platform. And there are certain to be numerous changes that come out of Manulife's purchase of AIC.

Volatile markets, slower asset growth and industry consolidation have contributed to the current wave of activity, but the reality is, the industry's marketing machine has left us with too many funds in Canada.

But before I address the patience question, let me provide some background.

When I moved to the buy side in 1991, I started in an institutional role. The clients I served were pension plans, endowments and corporations. Each had a formal process for picking and monitoring their money managers and they were usually assisted by a consultant who scrutinized performance, style and organizational changes. They were hyper-sensitive to any shifts in philosophy or personnel.

I learned early on that we had to be very clear about what we were offering - investment philosophy, people and business practices - and stick to it. Obviously performance was of paramount importance, but if we took care of those three things, we could build a sustainable business. If, on the other hand, clients came to us solely in pursuit of past performance, then we would eventually lose them when our approach was out of favour and returns were lagging.

The philosophy, people and practices criteria are still relevant to me in building a private wealth business at Steadyhand, and they should be important to all buyers of investment services. A fund's performance will ebb and flow, but its principles and people should not.

So, why do I say investors are too patient? Because too many of the changes they are subjected to don't stand up to the three criteria.

Consider the following example. You receive notice that your international equity fund is being merged into a global dividend fund. You're told the new fund has performed better and has the same fee. (Note: This is not an extreme example - over the past five years a slew of conventional equity funds became "dividend" funds.) So what has changed? Well first, the mandate of the fund has been altered by expanding the geography (global includes the U.S., international doesn't) and restricting the investment approach. The fund is now constrained to dividend-paying stocks, so it's unlikely that technology, resources or emerging markets will be included. And you have a new portfolio manager.

What looks like a simple name change on your statement represents a dramatic change of personnel, approach and role the fund will play in your portfolio. And in some cases, by merging a poor performer into one that is in a hotter category, the fund company is doing exactly what it doesn't want you to do - chase performance.

Measuring your funds against the philosophy, people and practices is not easy. The portfolio manager and investment philosophy are intertwined and sometimes they're inextricably linked. Indeed, it's hard to separate the two when it comes to investors like Eric Sprott, Frances Chou or Frank Mersch. They are the philosophy.

If you own a fund because of a particular manager, and that person goes elsewhere, the decision is easy. It's time to move on. I can think of two striking examples of this in recent years - Alan Jacobs' move to Sprott and Kim Shannon's shift to Brandes. In both cases, Sceptre and CI replaced their stars with capable managers, but nonetheless, the client's reason for owning the fund had been taken away.

Sometimes the investment approach has a history and is more enduring than any one individual. At Burgundy and Beutel Goodman for instance, the investment teams are fine-tuned from time to time, but the approach never changes. The "who" is important, but not as much as the "how."

So every change is different and they don't all necessitate the client taking action. But like my old institutional clients did when there was a significant shift in investment philosophy, people or business practices, you should at least put the fund on a watch list. In a well-constructed portfolio that holds between five to eight funds, every slot has a purpose. If someone else is making changes to it, you need to pay attention.

© 2007 The Globe and Mail. All rights reserved.

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