Canadian equity funds beaten up in November

Mutual funds that invest in Canadian equities, particularly those that focus on the resource sectors, had terrible returns in November, according to performance data released by Morningstar Canada.

Morningstar says the S&P/TSX Composite Index posted its worst one-month performance since the trough of the post-dot.com bear market more than five years ago. All domestically focused equity and balanced fund categories declined, and 30 of the 42 Morningstar Canada fund indexes suffered losses for the month.

The primary reason for this was a downturn in resources. Jordan Benincasa, fund analyst with Morningstar Canada, says around 70% of the median Canadian equity fund’s assets are allocated to natural resources and financials. Therefore, any drag in those sectors greatly reduces overall fund performance.

“While the surge in resources has been beneficial for Canadian equity and small- and mid-cap funds over the past several years, the risks associated with having high concentrations in that area were on full display in November,” Benincasa says. “Over the last several years, resources have made up a significant portion of Canadian equity funds, so resources do play a very strong role with regards to performance. Basically, if resources don’t do well, it’s safe to assume the Canadian equity categories will also not do well.”

Energy stocks were not immune to this downturn, even with record oil prices. Benincasa says the controversial decision to increase royalties on energy producers in Alberta has specifically hampered Canadian energy stocks.

“Despite historically high oil prices, the new Alberta Royalty regime adversely affected oil and gas stocks by creating concerns that companies would have less incentive to initiate new projects.”

Benincasa says companies like Canadian Natural Resources Ltd. have already reduced provincial natural-gas drilling and are turning their attention elsewhere.

All of this has put domestic resource stocks in a rut. The worst of the worst category was the volatile Morningstar Precious Metals Equity Fund Index, which posted an 8.6% loss. Morningstar says funds in this category tend to hold about three-quarters of their assets in domestic stocks.

Other categories that experienced heavy losses last month include the Canadian Small/Mid Cap Equity (-8.1%), Natural Resources Equity (-7.5%), Canadian Focused Small/Mid Cap Equity (-6.9%) and Canadian Equity (-6.1%).

One bright spot on the month was the falling loonie. Its retreat provided beleaguered foreign equity investors with a bit of a break in November. The Canadian dollar’s rise had been taking a substantial bite out of foreign equity returns. The reversal of this trend allowed investors to recoup some of those losses and in some cases even offset the underlying negative performance of some foreign funds.

Morningstar notes most of the world’s major stock market indexes suffered significant losses during the month as the sub-prime mortgage fallout and real estate downturn in the U.S. continued to take their toll, but these losses were negated by the loonie’s sharp depreciation.

For example, the S&P 500 Index of large-cap U.S. companies was down 4.2%, but Canadian investors benefited from a 5.1% rise in the U.S. dollar versus the loonie. The effect was even more pronounced with funds focused on Japan, where the benchmark Nikkei 225 Index dropped 6.3% but the yen gained 8.6%.

Morningstar’s Global Equity Fund Index was down only 0.1% for the month, while the International Equity, U.S. Equity and European Equity fund indexes were up 0.4%, 0.3% and 0.1%, respectively. The Morningstar Japanese Equity Fund Index ended the month with a net gain of 1.6%, its best monthly performance since February.

Morningstar doesn’t specifically track how currency affects the performance, so in some cases the actual returns could be greater due to more favourable currency conditions.

“The majority of funds in the foreign equity categories are not currency hedged. Their performance would be mixed in with hedged and non-hedged funds,” Benincasa says. “The decline of the U.S. dollar has negatively affected returns in the global equity category — you have to realize about 50% of that category is allocated to U.S. equities; the rest is to other international equities. It’s quite difficult to figure out which currencies helped performance and which ones did not.”

November also breathed new life into another slumping category, health-care equity. According to Morningstar, this category, which invests almost exclusively in U.S. and overseas stocks, gained a boost from the drop in the loonie. It was the top-performing fund index, with 4.3% growth in November, paring back its year-to-date loss to 8.4%.

“After a multi-year stretch of underperformance, the health-care category has shown some signs of life,” Benincasa says. “However, not all stocks in the sector benefited equally. Large-cap drug makers such as Pfizer continue to struggle under the weight of increased generic competition, while biotechnology bellwether Amgen has suffered amid potential regulatory troubles.”

As is usually the case during a market downturn, fixed income categories did well in November. The Morningstar Global Fixed Income Fund Index turned in the second-best return overall — a gain of 3.8%. Canadian Long Term Fixed Income came in third, with a 2% gain, while Canadian Fixed Income and Canadian Short Term Fixed Income ranked fifth and sixth, up 1.2% and 0.8% respectively.

Filed by Mark Noble, Advisor.ca, mark.noble@advisor.rogers.com

(12/04/07)

Mark Noble