Foreign equity funds set to rebound?

(March 2006) After several years of poor performance — both in terms of sales and investment returns — foreign mutual funds appear to be levelling off, as total assets under management stabilize, according to research from Investor Economics.

“Though currently out of favour, we believe this theme will reassert itself,” reads the latest issue of Investor Economics’ Insight. “So do a number of fund companies, as evidenced by ongoing product development and the emphasis their advisor communications now put on international investing.”

By the end of January, about 51% of international equity funds were in redemptions, which may sound high, but it is considerably better than the 69% that were in net redemptions in the first quarter of 2005. Among U.S. equity funds, the trend is similar, with 60% in redemptions, compared to 67% in 2005.

“Gross sales of international equity funds bottomed out early last year and have since been steadily improving,” according to Insight. “Several equity subclasses recorded positive net flows in January. Among them: global, Japan and international balanced.”

U.S. equity funds have shown less steady improvement, however. While they have enjoyed slightly better gross sales than their international counterparts — at 16.2% compared to 15.2% growth — they have suffered higher redemption rates as well — at 18.6%, compared to 17.7%.

The apparent gradual return to foreign investment funds has so far pointed to a shift among fund companies. In 2000, the top-selling funds largely belonged to the largest companies in the international space, as measured by assets under management. Only two of the top-selling fund complexes were not among the top ten largest companies — those being AIC and Talvest.

Fast-forward to January 2006: only one of the top ten sponsors is in the top sellers’ list, as Mackenzie’s immensely popular Cundill Value funds boosted that firm’s fortunes. Brandes is the top selling international fund company — explaining the disappearance of AGF from the list — and several of the banks are also selling well.

AIM Trimark, with the largest AUM in the international equity arena at $14.8 billion, does not crack the top ten sellers list. Nor do number three and four asset managers Franklin Templeton and Fidelity. Among U.S. equity funds, the trend is similar, though less pronounced, with only four firms listed among both the largest and the best-selling.

“The large, established players may face fierce competition from the newcomers,” Investor Economics suggests. “Competitive pressures are likely to be very high, and we expect a continued influx of new ideas and products as players try to carve out some product niche strategies to get a leg up.”

Since late 2000, Canadian investors have been divesting from foreign mutual funds, and assets under management have declined by more than $33 billion to $139.7 billion, as of January 2006. They now make up just 24.9% of all long term mutual fund holdings, down from 43.6% in December 2000.

The Investor Economics team suggests that actual redemptions from foreign investment funds was not so much to blame for this decline in market share. Instead, they point to the runaway gains in both the Canadian stock markets and the loonie.

Between 2000 and 2006, net redemptions of foreign funds has totaled nearly $14 billion, accounting for less than 16% of the inflows experienced in the 1990s rush to foreign funds.

“This was nowhere near a ‘rush for the exits,’ even if we allow for the cast that the volume of outgoing foreign fund redemptions would have been deflated by the decreased foreign asset valuations,” reads Insight.

Perhaps the biggest problem with foreign investments has not been their performance, but the stronger gains made in the Canadian dollar. While the MSCI World Index has gained 75.9% in U.S. dollars since 2002, the return in Canadian dollars has been only 28.5%.

“More so than redemptions, the appreciation of the Canadian dollar has had a damaging effect on both the value of the foreign fund assets as well as their relative investment returns,” the researchers conclude.

Canadian investors may hold more foreign content than the top line numbers indicate, as domestic mutual funds held $34 billion in foreign investments as of January 2006.

Foreign content in domestic funds now accounts for 20% of the foreign holdings in the fund industry. Foreign investments in all mutual funds amount to $168.8 billion, or 30.1% of all long term mutual funds.

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

(03/10/06)

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