Global funds suffer from Canadian optimism

(November 14, 2005) While the mutual fund industry has enjoyed strong sales throughout 2005, Canadian investors have consistently demonstrated a preference for domestic equity, preferably with an income component. To date, such a strategy has proven quite profitable for investors and managers of these favoured funds. Foreign equity…not so much.

“The whole global species is under pressure at the moment,” says George Morgan, executive vice president, global equity group, Templeton Global Advisors, and lead manager Templeton Growth. “Most of our competitors, with maybe one or two exceptions, have net outflows. If anything, they’ve quickened in the last year or two.”

The Templeton Growth Fund has seen steady redemptions over the past several years, despite decent returns that topped the global index. Fund assets have fallen from a high of over $12 billion in 1999, to just over $5 billion today.

“From a personal pride point of view, would you rather have a fund that is taking in money, than a fund that is flowing money out?” he asks rhetorically. “Of course I’d prefer the former.”

Morgan says he understands why Canadians have shunned global investments, but thinks investors are being short-sighted. As the Canadian dollar raced from 65 cents US to 85 cents, foreign investment returns were trimmed or even wiped out completely.

Add to that, the booming income trust market and in incredible rally in Canada’s three largest industries — finance, energy and materials — and its easy to see why Canadians have been slow to look abroad.

Dan Hallett, president of Dan Hallett and Associates, says the long-term outlook for commodities, given the rapid growth of China and India, makes Canadian equity more attractive to domestic investors. Whether the markets can keep up or not, he says it is understandable that the average investor would view the Canadian market as a winner.

“The problem is that the overall fund flows don’t usually head in the right direction, using history as a guide,” Hallett says. He points out that the current trend is simply the reverse of late 1999, when Canadian investors pulled nearly $2 billion out of their underperforming Canadian equity funds.

“At the time, foreign funds boasted much better performance than Canadian funds, thanks in part to a falling dollar,” Hallett says. “Today, it’s the exact opposite. Canada is in great shape, our dollar has strengthened, and people aren’t enthused about investing globally. Waiting on the sidelines until global funds post three or five years of strong performance has not proven a profitable strategy in the past – so what makes people think it’s any different this time?”

Despite the elimination of the foreign property rule in the 2005 budget, retail investors have yet to jump on board. Many advisors point out that there were already strategies in place to get around the 30% limitations, such as clone funds, so dropping the FPR shouldn’t have a huge impact. Still, sagging flows in global funds suggest that many Canadians are keeping their capital at home.

“People have decided in Canada that global is not a very good place to be — completely the inverse of where they were 10 or 11 years ago,” Morgan says, but as a believer in mean reversion, he thinks the trend will again reverse. In fact he says there are already signs of a shift.

“Institutional investors are moving more money out of Canada into foreign these days, in contrast to what seems to be happening at the retail level,” he says. “Institutional guys are not always smarter, but on average they should be — they’re more informed.”

The most basic rule of investing remains: “buy low, sell high.” Not only do investors seem to have forgotten the second half of the equation, but in today’s Canadian equity landscape, Morgan says there are few bargains left.

“Trees do not grow to the sky — this will not continue,” he says. “You’ve had an 80% return for some oil and gas stocks in the last 12 months, mines and metals have done well, banks have done well — there’s not much left to invest in, in Canada on a diversified basis.”

“We earnestly believe that people will be well served to take a portion of those Canadian dollar profits and put it abroad,” Morgan says. “My biggest fear is that the individual investor will be driven at the wrong time into the wrong asset or asset class.”

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