Returns help, but fashion is key in fund sales

(July 27, 2005) It has become something of an axiom that investors continue to chase performance in the mutual fund world, but recent research indicates there is more driving sales than the latest performance ranking for a given fund.

Despite repeated encouragement toward long-term investing, many investors still take a short-term view when making their decision to buy or sell funds. But surprisingly, fund performance does not appear to be the most important factor in making such a decision, according to the latest research in Investor Economics Insight.

“Performance helps, but is unlikely to guarantee sales success in an industry where product differentiation is becoming more and more difficult,” the report says. “Good performance can boost sales for a mutual fund, but is not the be-all and end-all that it was in the booming 1990s. Asset class appears to matter more.”

As an isolated example, Insight points to the AIC American Focused Fund, which despite its five-star Morningstar Rating has been suffering net redemptions, with negative fund flows of $335 million over the 12 months ending in May 2005.

Conversely, Desjardins Canadian Balanced Fund has only a one-star rating, but has positive fund flows of $172 million. Canadian balanced funds have been a “hot” category over this time frame, as investors have shifted their focus slightly from income investments.

On a broader scale, this trend continues, with “hot” asset classes outselling the out-of-favour fund categories.

At the end of May 2005, the Canadian Income Trust fund category had 12-month net in-flows of over $2.5 billion, making it one of the hottest categories in the industry. And why not? The media was flogging the asset class, the market was churning out product and the category had an average one-year return of 25.5% and a three-year return of 17.3%.

These net flows pale in comparison to the top selling Canadian Income Balanced fund category, which posted net in-flows of nearly $10.1 billion. What’s more, this category posted significantly lower returns — 11.3% for one year and 7.7% over three years.

But Insight points out that the Income Trust category is relatively small and new to investors, giving it cache. The $2.5 billion in-flow represented an increase in assets of more than 35%.

The Income Trust category’s top-ranked performance landed it in the number four spot in terms of absolute net flows, behind Canadian Dividend and Canadian Bond funds.

The dividend category raked in $7.3 billion on one-year returns of 14%, while bonds posted a one-year return of 9% and raked in $4.381 billion. The Canadian Balanced category rounded out the top five with in-flows of nearly $1.3 billion and one- and three-year returns of 10.4% and 5.8%, respectively.

In fact, categories with superior returns to bonds fell into the bottom of the rankings in terms of net flows. Canadian tactical asset allocation funds had returns comparable to Canadian Balanced, with one- and three-year returns of 10.7% and 6.2%, respectively. Yet the category fell out of fashion with investors, posting net out-flows of $1.137 billion. Similarly, Canadian Equity had one-year returns of 13.1% over the same period, yet saw net out-flows of just over $1 billion.

“Obviously, investors have been chasing some positive returns but not others,” say the authors of Insight. “This might be due in part to lingering wounds from the bear market, the first that many investors and some advisors experienced.”

The report also suggests investors are chasing the more recent and more obvious returns in the income market. “Either way, this supports the notion that performance may be helpful but does not guarantee sales.”

Familiarity also seems to play a role. Many Canadians are comfortable investing in fields such as resources, being the traditional backbone of the economy. Over the 12 months ending May 2005, assets invested in the natural resource category grew by 22.8%, as the funds returned 26.4%, with three-year returns of 18.3%.

Emerging markets funds also offered highly attractive returns of 19.8% and 9.7% over the one- and three-year time horizon, but saw their asset base shrink 7.2%. Perhaps Canadian investors realized they were making healthy returns, but distrusted the stability of their investments and took their profits.

The study also found that the distribution network, as well as sales and marketing strategies can help to counter the detriments of poor performance.

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

(07/27/05)

Steven Lamb