Morningstar reveals where the pros invest

(September 22, 2005) Clients expecting to reap a windfall from the energy sector’s massive run up may be in for a shock, as most mutual fund managers remained underweight in the sector in the first half of the year.

According to Morningstar Canada’s first ever “Tracking The Pros” survey, equity fund managers apparently distrusted the energy rally, doubting its sustainability. For the 12 months ended June 30, 2005, fund managers instead held overweight positions in the consumer discretionary sector, expressing confidence in the global and domestic economy and believing that consumer spending would remain strong.

Given the massive weighting of the energy sector in Canada, it may be easy to understand fund managers’ trepidation. In fact, the Morningstar Canadian Equity Fund Index’s weighting in energy was 5.5 percentage points below the benchmark. That nearly matches the 5.3% overweighting in consumer discretionary stocks.

The underweighting in energy became exaggerated from early April onward, as rallying energy stock prices distorted their relative weighting on the index. The sector most closely tracking the benchmark index was utilities, in which managers maintained a relatively stable, slight underweighting throughout the year.

Among other fund indices, sectoral preferences varied a little.

Among Canadian small cap funds, materials were underweighted by 8.6%, compared to the benchmark BMO Nesbitt Burns Small Cap Index. Morningstar analysts ascribed the aversion to materials to developments in China, which became a net exporter of steel during the survey period, rather than a consumer. Industrials attracted an overweighting of 6.1%.

In contrast, U.S. equity fund managers underweighted industrials by 2%, versus the S&P 500. These managers apparently agreed with their counterparts running the Canadian equity portfolios, overweighting their positions in consumer discretionary stocks by 5%.

Financials were also greatly overweighted, and briefly the most overweighted through late spring. Telecom weighting most closely matched the index since February.

In the global equity arena, managers underweighted financials by 4.8% relative to the MSCI World Index and were again overweight in consumer discretionary stocks, by 6.5%. Technology weightings tended to most closely match the index weighting.

In terms of where money is being allocated, managers have been most underweight in U.S. investments — by about 15%, at the end of the survey period. This is fairly easy to achieve, due to the massive 48.5% weighting the U.S. markets carry on the world index. European investment was also underweighted, while emerging markets were overweighted by the Morningstar Global Fund index. Allocation to Canada has pretty much matched the MSCI index.

Filed by Steven Lamb, Advisor.ca, steven.lamb@advisor.rogers.com