Pick some home-run-hitter funds to boost your return
Wayne Cheveldayoff
Province
The Canadian equity-mutual-fund landscape is changing. The lines are blurring and investors wanting to know exactly what they own or are about to buy would benefit from a Sherlock Holmes-type magnifying glass to read all the fine print.
Canadian equity mutual funds used to be pretty standard — 95 per cent equities and about 5 per cent cash. The stocks were at least 70-per-cent Canadian, given the government’s 30-per-cent restriction on foreign content for RRSP eligibility.
The government restrictions have been lifted, so an equity mutual fund labelled “Canadian” could have very high foreign content or none at all.
An equity mutual fund is normally thought of as holding stocks, but many have also started buying income trusts — a natural move, since income trusts, in practical terms, are really high-yield equities.
Another innovation of late is that some equity mutual funds have had their prospectuses changed so that they could take short positions in stocks of up to 10 or 15 per cent of net asset value — a little bit of hedge fund thrown in under the mutual-fund banner.
If that is not enough to sow confusion and have you reaching for the headache pills, consider that some mutual-fund managers have also issued closed-end funds, traded on the TSX, that mimic the returns of their mutual funds. To date, this has mainly been in the income-trust sector.
A key difference is that these closed-end funds have the ability to borrow up to 20 per cent of the net asset value — meaning they use leverage to, hopefully, boost returns versus their mutual-fund counterparts.
Before you tell your adviser or personal banker to “just put it where you think it makes sense,” consider what the cost would be of not working hard to get the highest return possible.
The RRSP Savings Calculator at the website www.investorED.ca shows that a $40,000 RRSP, with no further contributions, would increase to $402,506 in 30 years if it obtained an eight-per-cent compound annual rate of return. That would supply $37,706 annually for 25 years of retirement.
But if you were able to squeeze out another two percentage points of return each year over 30 years — obtaining a 10-per-cent annual return — the RRSP at retirement would have $697,976 and would supply you with $76,894 annually for 25 years in retirement.
So it obviously pays to peruse the mutual-fund stats to get the right managers for your RRSP.
It is true that looking at only last year’s return in judging a mutual fund isn’t the best way to go.
Take, for example, the Sprott Canadian Equity Fund. It has a top five-star rating from Globefund.com and it has handily beat the S&P/TSX total-return index over three- and five-year periods.
Sprott’s three-year return after fees is 26.6 per cent annually, versus 21.6 per cent for the index. Sprott’s five-year return is 32.3 per cent annually, versus 6.6 per cent for the index.
But if you looked only at Sprott’s one-year return of 13.19 per cent, versus 24.1 per cent for the index, you would probably give it a pass.
This raises the question of why some funds have so much volatility versus the index. Sprott aims to hit home runs, whereas other managers may be content with singles (matching the index). Home-run hitters sometimes strike out.
But if you want to be sure to get the best longer-run returns, you will need to know who the successful home-run hitters are and make sure you have at least some of them on your RRSP’s team of managers.
You aren’t likely to do as well if your team consists of managers who are trying to match or exceed the index by a little.
Instead of having “closet indexers” in your portfolio, you may be better off with index-related exchange-traded funds with rock-bottom management expense ratios (less than 0.5 per cent). At least, then, you will be assured that you won’t underperform the index.
What should be obvious by now is that you need to do a lot of research, or lean on the help of a knowledgeable investment adviser, to make sure you get the right mutual funds into your RRSP.
Accelerating your returns
Doing better than a GIC means extra risk
TORONTO — Common prudence dictates that investments not be made up of equities alone, which is why the classic portfolio consists of 50 per cent stocks and 15 per cent cash anchored by a solid 35 per cent in fixed income.
Some investment strategies even eschew potentially volatile equities altogether and stick strictly to fixed income, which just goes to show how important they are in providing financial stability.
Either way, the problem is the same — how to maximize those fixed-income returns.
It’s especially challenging in these days of low interest rates that show little hope of going much higher. If anything, the Bank of Canada and the U.S. Federal Reserve could move to send rates lower again later this year. The challenge, then, is to get percentage returns above the low single digits.
“What can someone do and be sure of getting their money back? They can do four per cent,” said Brendan Caldwell, president of Caldwell Securities.
“So if you sat down today and said: ‘Right, I would like to invest my money in something secure that I know I will get back, in three, five, seven, nine years, in my RRSP,’ you’re looking at four per cent or some variation on the number, give or take a quarter.”
Getting above that level means more work — and more risk.
Even getting that four per cent or so requires making a choice or two.
There’s not a great deal of difference between a guaranteed investment certificate and a 10-year Government of Canada bond — but Caldwell favours the bond route.
“We find that bonds are better for most people and they typically pay a higher rate of interest,” he said. One reason for that is that interest is calculated on a semi-annual basis for the bonds and on an annual basis for GICs. And if you’re compounding more often, your money grows faster.”
As of mid-February, the yield on a 10-year Government of Canada bond was 4.2 per cent. They’re relatively easy to buy — just ask your investment adviser or bank branch.
Past the territory of four per cent or so, things get a bit tricky.
“Really, you could almost be assured that if you’re getting a higher yield, you’re taking more risk to get it,” observed Caldwell.
“If you want five or six or eight per cent, you’re going to pay increased risk to get that.”
Patricia Lovett-Reid, senior vice-president at TD Waterhouse, suggests that one area to look at is foreign-pay bonds.
She thinks they are a good way to diversify your portfolio because you are purchasing a bond that’s denominated in another currency.
“And the Canadian dollar is expected to depreciate against the U.S. dollar by four per cent this year, against the euro by 5.8 per cent [and] the Japanese yen by six per cent,” she said. “So the example is: If a bond yields six per cent, and the currency depreciates four per cent, you’re only going to get a two per cent gain — but it also works the other way.”
Reid also points to short-term floating-rate notes — a note that has a variable rate of interest: “So adjustments are made to the interest rate on the note every six months, and they tend to be tied to a benchmark. So what this does in a rising-interest-rate environment — which most think this environment is — you could look at a short-term floating-rate note.”
Both Reid and Caldwell advise investors to take a good, hard look at corporate debt before jumping in, because you can get into trouble investing your money in some of the best-known companies.
Reid cited Ford’s corporate debt, which has been downgraded by Moody’s Investor Services to B high: “What that means is, it has a one-in-five chance of default on its interest and/or principal.”
She added that General Motors Acceptance Corp., GM’s finance arm, “has a double-D [rating] with a negative outlook. It has a one in 10 chance of default — and it pays nine per cent.”
If you have a limited appetite for risk in order to get that higher yield, Caldwell said “the only way for most investors to attack it would be some sort of ‘barbell’ portfolio . . . government bonds on the one hand, high-yield bonds on the other, in a pool.”
© The Vancouver Province 2006