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Dos and don'ts of buying top performers

Everyone likes a winner, but to the aura of high ratings and industry honours, add old-fashioned research and risk assessment

INVESTMENT FUNDS REPORTER

As the deadline looms at the end of this month for registered retirement saving plan contributions, investors will see more companies boast about their award-winning mutual funds.

While there is an aura around award winners, and they can be a good source of ideas for further research, people should not jump into them with both feet, fund watchers warn.

Everyone's investment needs differ, and there are no guarantees these funds can continue their winning ways, especially if they have had eye-popping returns in recent times.

U.S.-based fund research firm Lipper Inc., a unit of Thomson Reuters, Thursday handed out its 2011 awards in Toronto, while the Canadian subsidiary of U.S.-based Morningstar Inc. doled out its honours last November.

"Winning an award is an accolade from the industry," said Jeff Tjornejoj, head of Lipper Americas research. "There is a lot to consider when buying a fund. The fact that it won an award is a mark of distinction, but it doesn't confer that it is the only choice out there."

Investors or their financial advisers first need to map out an asset-allocation strategy that defines how much money to put in bonds versus stocks based on factors such as age and risk tolerance, and then figure what kinds of funds could help fit that bill, he said.

"Don't buy funds in isolation," he said. "An award winner may not be appropriate. Some like the faster ride you may get through a precious metals equity fund, but somebody who is conservative by nature would probably not appreciate that volatility."

Fund awards are not alike. Lipper Awards, which are given for one-, three-, five- and 10-year performance, are determined by a computer-generated test for delivering strong performance with lower risk than their peers. The same manager may not have run the fund for the entire time.

Morningstar's Canadian Investment Awards are chosen more subjectively. Industry analysts nominate the funds, and can evaluate them within any framework they choose. The awards are not year-specific, but the manager must have overseen the fund for at least three years.

Award winners can be a starting point for research, but "there are going to be some interesting funds that don't ever get mentioned at any of the awards ceremonies," said Dan Hallett, a fund analyst at HighView Financial Group, and one of the judges for the Morningstar awards.

"Not every fund that I nominate get to be finalists and winners. At the same time, there are going to be good funds that slip through those quantitative filters that Lipper applies to its awards."

BMO Guardian Monthly Dividend Ltd. Classic was one fund he nominated in the Canadian dividend and income category, but it didn't make it as a finalist. That fund charges a low fee of 1.4 per cent, and is run by Guardian Capital Corp., which "we have high regard for," he said.

When choosing funds, "at the minimum, you want to make sure that the person or persons responsible for the track record are still in place," Mr. Hallett said. There are no guarantees that the manager of an award-winning fund will stay with the firm for very long, or whether a successor can maintain the previous strong performance.

Sentry Select Diversified Total Return, which won a 2010 Lipper Award for three-year performance in the Canadian focused equity category, was managed by Andrew McCreath. However, he left Sentry Investments last August, and that fund is now run by former co-manager John Kim.

"We parted ways" because of a difference in investment philosophy, said Sandy McIntyre, chief executive officer of Sentry Investments, which won a 2011 Lipper Award for best equity fund family for the second year in a row. Mr. McCreath, who has been a regular market commentator on the financial news television channel BNN (Business News Network), agreed that was the case.

The musical chairs among fund managers continues even in the midst of the current RRSP season. Last week, Wendy Chua, who won a 2008 Lipper Award for three-year performance in running Mackenzie Universal Health Sciences Class, left Mackenzie Financial Corp.

The fund company decided that the $30-million fund was too small to warrant keeping a manager with a narrow specialty such as health sciences, and appointed Ian Ainsworth, who co-heads Mackenzie's growth team, to run the health-care equity investment.

But investors should also be careful about buying a fund winner in a hot sector, particularly just after it has posted spectacular double-digit, or even triple-digit gains, Mr. Hallett cautioned. "If it has gone up that high ... chances are you will get pinched in the other direction."

Award-winning equity funds can disappoint should stock markets get creamed like they did in the global meltdown during the financial crisis, he added. "They [funds] are not miracle workers. ... In a market like 2008, if you were invested in stocks, nothing was going to save you."

But bond funds, which are an important part of a balanced portfolio, is one sector where investors can take award winners more seriously, Mr. Hallett said. "What you find is that the best bond funds do emerge time after time. But it's not because five- or 10-year returns are that meaningful, because they are not ...

"It's just that bond fees are so important," he said. "Of the funds that outperform, almost all of them are going to be lower-fee funds. That is what gives you strong long-term outperformance in bonds."

Some funds may even win both Lipper and Morningstar awards.

In the Canadian small- to mid-cap equity category, Beutel Goodman Small Cap (D series), which is run by Stephen Arpin and William Otton of Beutel Goodman & Co. Ltd., won both the 2011 Lipper Awards for three- and five-year performance, and the 2011 Morningstar Canadian Investment Award.

In the emerging markets category, AGF Emerging Markets, which is overseen by Patricia Perez-Coutts of AGF Management Ltd., won the 2011 Lipper Awards for three- and five-year performance, and the 2011 Morningstar Canadian Investment Award.

In addition, RBC Canadian Equity Income Fund, which is run by Jennifer McClelland of RBC Global Asset Management, won three 2011 Lipper Awards and a 2011 Morningstar Canadian Investment Fund Award in the Canadian dividend and income category.

Award winners can also be used, not only at the beginning, but also at the end of researching for a fund, Mr. Tjornejoj suggested. "Once you know what you are after, ratings and awards might give you some confidence that you have reached a good decision."

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2011 LIPPER FUND AWARDS, THREE-YEAR RETURNS

Fund nameClass name1-YR % RTN TO OCT. 313-YR % RTN TO OCT. 315-YR % RTN to OCT. 31 10-YR % RTN TO OCT. 31
Fidelity ClearPath 2020 Portfolio Series A2020 Target Date Portfolio2.08.42.5
Fidelity ClearPath 2045 Portfolio A2025+ Target Date Portfolio0.99.21.8
Dynamic Far East Value AAsia Pacific Equity-18.121.42.06.5
RBC Canadian Equity Income Series ACanadian Dividend & Equity Inc13.025.212.6
DFA Canadian Core Equity ACanadian Equity-2.213.52.4
Dynamic Diversified Real Asset ACanadian Equity Balanced2.123.26.0
Standard Life Corporate Bond Series ACanadian Fixed Income3.010.33.54.9
Fidelity Income Allocation ACanadian Fixed Income Balanced5.014.05.6
Fidelity Canadian Large Cap ACanadian Focused Equity15.816.87.69.5
National Bank Small Cap Investor SeriesCanadian Focused Sm/Mid Cap Eq-6.523.24.78.9
Middlefield Income Plus Class Series ACanadian Neutral Balanced5.513.15.39.8
SEI Short Term Bond OCanadian ShTrm Fixed Income4.16.54.7
Beutel Goodman Small Cap DCanadian Small/Mid Cap Equity5.127.29.112.7
AGF Emerging Markets MF SeriesEmerging Markets Equity-9.720.56.912.7
BMO European AEuropean Equity1.66.8-5.82.0
TD Entertainment & Communications Investor SeriesGlobal Equity2.617.34.25.6
BMO Guardian Global Diversified MutualGlobal Equity Balanced-0.110.22.6
RBC Global Corporate Bond Series AGlobal Fixed Income3.59.95.8
CI Portfolio Series Income AGlobal Fixed Income Balanced2.79.03.75.0
CI Signature High Income AGlobal Neutral Balanced3.813.43.89.7
Trimark Global Endeavour Class Series AGlobal Small/Mid Cap Equity9.018.7-0.2
Excel China Series AGreater China Equity-21.113.62.73.6
Fidelity American High Yield Currency Neut AHigh Yield Fixed Income3.716.9
Investors International Small Cap Class Series AInternational Equity-6.215.4-0.1
Mackenzie Focus Japan Class Series AJapanese Equity1.30.2-10.0
TD Science & Technology Investor SeriesMiscellaneous - Sector Equity10.718.75.2-0.1
Dynamic Focus+ Resource Series ANatural Resources Equity-0.236.910.921.6
Mackenzie Ivy Enterprise Series ANorth American Equity5.08.32.54.7
Sentry Precious Metals Growth Series APrecious Metals Equity-3.967.317.822.8
CIBC Canadian Real Estate AReal Estate Equity3.115.41.08.9
CI Cambridge Cdn Asset Allocation Corp Cl ATactical Balanced4.89.6
TD NASDAQ Index Investor SeriesUS Equity9.918.24.14.1
Trimark US Small Companies Class Series AUS Small/Mid Cap Equity18.718.01.7
Source: Thomson Reuters

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PASSIVE INDEX FUNDS CAN BE WINNERS, TOO.

Passive index funds can qualify as Lipper Award winners in addition to their actively managed cousins.

TD Nasdaq Index Investor Series won a 2011 Lipper Award for three-year performance in the U.S. equity category, while the CIBC Nasdaq Index A won a Lipper Award for five-year performance. Both track the Nasdaq 100 Index, which includes 100 non-financial companies based on market value.

Index funds are permitted to be winners because "we want investors to know that sometimes even active strategies will fall short of being the best in a classification," said Jeff Tjornejoj, head of Lipper Americas. "If you want to read between the lines, active managers struggle in that classification."

Lipper Awards are given to funds that deliver strong performance with lower risk than their peers, and that is determined by a computer-generated test for those attributes. The latest awards, which are given in categories defined by the Canadian Investment Funds Standards Committee, is for periods ending Oct. 31, 2011.

While TD Nasdaq Index Investor Series won the Lipper honour, the lower-fee TD Nasdaq Index e-Series, which can be purchased online through TD Canada Trust or TD Waterhouse Discount Brokerage, has a better track record because of its lower management expense ratio.

The Investor Series won because it is the "primary share class," but the cheaper version is a better bet for investors who can buy them online, Mr. Tjornejoj said.

Shirley Won

© 2007 The Globe and Mail. All rights reserved.

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