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How to achieve buy-and-hold harmony

You sold when the market tanked, then missed out on the upturn. Mixing passive and active investments could have eased the pain


Radical thought: Pay a little less attention to how much profit you expect from your investments and more to how well you'll be able to live with them over the years.

The recent bear market notwithstanding, buy-and-hold is still the best approach for the most investors. We're all good at buying investments, especially in RRSP season. It's the holding part that's the problem.

We buy, we sell, we buy something different. That's the pattern that may help explain a recent estimate from investment firm Russell Canada that people 50 and older have $300-billion sitting in low-growth investments like guaranteed investment certificates and savings accounts, a nine-year high. Many of these people bought stuff they couldn't live with, they sold it when the stock markets tanked and then bought something conservative.

How's it working out for them? GICs are paying no more than about 3.6 per cent for five years, while many savings accounts are paying roughly 1 per cent or less and only a tiny minority are as high as 2 per cent. Meantime, the stock market surged 35 per cent last year, including dividends. With investments they could live with, maybe these investors would have been able to ride through the past two years instead of selling low and then missing an upturn.

A suggestion for finding a comfort level in your registered retirement savings plan or other investments: blend active and passive investments. In plain English, that's mutual funds and exchange-traded funds.

Mutual funds are actively managed investments, which means they're run by managers who seek out what they believe are the best stocks and bonds. It's the opposite approach to passive investments like ETFs, where the mandate is to mirror the return of a stock or bond index (note: ETFs are bought and sold like stocks).

The ideal outcome of blending the two is that the ETF will wire you directly into what a major stock index does, for better (that would be 2009) and for worse (that would be 2008). The mutual fund, if chosen correctly, will offer more protection in down markets and probably lag when stocks are soaring. The overall package should be something you can live with more comfortably than just the ETF or mutual fund alone.

Institutional investors know that blending active and passive strategies is an effective way to run a portfolio, and it's time that retail investors considered it.

An easy way to pair up active and passive funds is to evenly divide up the money you're investing in a particular component of your portfolio into a mutual fund and an equivalent ETF (check for a full listing of ETFs listed on the Toronto Stock Exchange).

You can't just buy any mutual fund, though. Too many funds more or less hold what the index holds, which is where the expression "closet indexing" comes from. If you match a fund up with an ETF, you want it to hold different stocks, emphasize different sectors and, on the whole, behave differently.

One way to find funds like these would be to look at their beta, a technical term for measuring a fund's volatility in comparison to its benchmark stock index. The index itself always has a beta of 1.0, and that's more or less the same number you'll find for an ETF that tracks the index.

When selecting funds to pair with an ETF, you could start your search with those having a low beta. That gives you an indication the fund behaves at least somewhat differently than its benchmark index, and that it's less risky.

Globeinvestor analyst Victor Tan has helped us out here by screening for low-beta funds in five categories: Canadian equity, Canadian focused equity, Canadian dividend and income equity, U.S. equity and global equity. An additional qualification was that the funds had to have assets of more than $20-million and a history of at least five years.

There are roughly 5,000 mutual funds and fund variations available in the Canadian market, but only a handful have the low beta score that signals an investing style significantly different from the composition of the benchmark index.

Remember, our starting principal here is that you'll buy the index through an ETF and look for a mutual fund that does things differently. The goal: a smoother ride than either a mutual fund on its own, or an ETF.

Let's try pairing up a popular Canadian market ETF, the iShares CDN LargeCap 60 Index Fund (XIU-TSX) with IA Clarington Canadian Conservative Equity, the lowest-beta Canadian equity fund on our list at 0.62.

XIU's top sector is financial services at 32.5 per cent of the portfolio; IA Clarington Canadian Conservative Equity's exposure to this sector was 17.8 per cent Jan. 31. XIU had 45.3 per cent of its assets in energy and materials, while the IA Clarington fund had just under 33 per cent.

Financials and resource names dominate the top five holdings of XIU - Royal Bank of Canada, Toronto-Dominion Bank, Suncor Energy, Bank of Nova Scotia and Barrick Gold. Four of the top names in the IA Clarington fund are comparatively conservative utilities or telecom stocks - BCE Inc., Enbridge Inc., Fortis Inc. and TransCanada Corp., with Bank of Montreal rounding out the Top Five.

The IA Clarington fund has the superior 10-year returns, which raises the question of why you wouldn't just buy this fund and forget XIU. The answer can be found in the behaviour of these funds in fast-rising markets.

With its scaled down holdings in financials and resource stocks, the IA Clarington fund lagged XIU by a large margin in 2009. At the stock market peak in August, 2008, its long-term numbers lagged XIU, too.

By combining XIU with the IA Clarington fund, you get the comfort of knowing that in a fast-rising market you'll have some exposure to the stocks that are leading the way. Just the opposite is true in down markets, where the careful touch of the IA Clarington fund should help limit losses. That was certainly the case in 2008.

Both XIU and Clarington Canadian Conservative Equity are good funds you can own separately. But you might just be more comfortable if you own them both, and that's huge.

Follow me on Facebook. I'm at Rob Carrick - Personal Finance


Mutual funds that go with ETFs

One way to find mutual funds that pair up well with index-tracking exchange-traded funds is to look at a measure of volatility called beta. A fund's benchmark index always has a beta of 1.0; the lower a fund's beta, the less likely it is to move in lockstep with the index. Here's a list of low-beta funds in various categories.

At Dec. 31 3 Yr Returns as of Jan. 31/10 Quartile
Fund Name ($ mlns) Beta 1 Yr 3 Yr 5 Yr 1 Yr 3 Yr 5 Yr
Canadian Equity
IA Clarington Cdn Conservative Eqty266.50.6221.33%-1.03%4.09%413
Beutel Goodman Canadian Equity1103.00.7628.52%-1.52%5.26%312
Mawer Canadian Equity109.10.7930.24%-1.18%5.95%211
Leith Wheeler Canadian Equity B164.90.8533.34%-4.06%4.60%222
Cdn Focused Equity
Mackenzie Ivy Canadian1812.60.327.76%-6.88%-1.32%434
Mackenzie Univ Canadian Growth868.40.5520.31%-1.39%3.25%412
Mackenzie Cundill Cdn Security 'C'1460.50.6130.86%-4.49%1.07%123
Hartford Canadian Value B29.50.6320.28%-3.62%3.69%412
AIM Canadian Premier597.70.6522.36%-5.15%5.27%321
CI Signature Dividend1460.70.5532.88%-1.57%3.36%212
Hartford Canadian Dividend B89.40.5620.08%-2.97%3.21%422
Northwest Canadian Dividend120.20.5721.47%-3.27%3.04%422
Bissett Canadian Dividend-A171.50.6532.24%0.10%4.28%211
Manulife Dividend Fund539.60.6931.56%-1.96%3.44%212
BMO Dividend4107.90.6919.50%-5.59%3.11%432
U.S. Equity
Dynamic American Value310.80.5215.67%-4.48%2.50%211
BMO NB U.S. Stock Selection25.00.829.08%-8.93%-2.41%411
CI American Value Corporate Class336.20.8412.71%-8.54%-1.77%311
Global Equity
Mackenzie Ivy Foreign Equity1966.40.5311.42%-3.00%2.04%411
Mutual Discovery546.30.5714.66%-5.43%2.85%411
Dynamic Global Discovery629.00.6724.23%-4.35%6.67%211
Renaissance Global Growth55.20.7015.57%-5.12%1.92%411
CI Global Managers Corporate Class71.00.7117.80%-5.97%0.73%311
Note: quartiles dividend funds in a category into four groups according to their returns; first quartile is best, fourth is worst
Source: Globe Investor

© 2007 The Globe and Mail. All rights reserved.

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