What's In A Name?
Funds' nice packaging sometimes holds surprises
This week, the US Securities and Exchange Commission (SEC) announced (http://www.sec.gov/news/mfnames.htm) that it was getting tougher on mutual fund marketing. The new rule will, according to the SEC "prohibit the use of mutual fund names that may mislead investors about a fund's investments and risks". A mutual fund with a name suggesting a particular focus or security concentration (i.e. "Stock", "bond", etc,) will have to invest at least 80% of its assets in accordance with its name - or not use such a specific name. This rule doesn't just apply to regular mutual funds, but also to registered investment companies like closed-end funds and exchange-traded funds. While we don't have this kind of regulation in Canada - yet - it should remind us that investors often need to pop open the hood to see what really makes their mutual funds tick.
As of the beginning of this year, the foreign content limit for tax-deferred savings plans - like RRSPs and RRIFs - was bumped up to 30 per cent from 25 per cent. When the higher limits were first announced a year ago, I estimated that funds that maximize foreign content by policy could have as little as 55 or 60 per cent in Canadian stocks. Foreign stocks of 30 per cent and cash of 5 to 10 per cent would leave no more than 65 per cent devoted to domestic stocks. As market prices move, that figure could be stretched further.
While maximizing foreign content has been a return booster for some funds over the last ten years, it has a downside. Those looking for a pure Canadian equity fund might be disappointed to find out that the fund they bought has much less than 100 per cent in Canadian stocks. To illustrate, Mackenzie's Ivy Canadian (a large cap Canadian stock fund) had about 65 per cent in Canadian stocks as of the end of 2000 - and that's with less than the maximum foreign content for 2000. Templeton Canadian stock held just 69 per cent in Canadian stocks at the end of last year. There are numerous other examples, but you get the point. Once funds have had a chance to direct more cash towards foreign stocks, you'll see that number drop. This will further narrow the universe of pure Canadian stock funds. However, this is just one example of potentially misleading fund names.
If you were to guess the proportion of the Janus American Equity fund's American stock content, what would you guess? If you guessed 60 per cent or higher, you'd be too high. This fund, run by US fund giant Janus Funds, has a uniquely flexible mandate. Despite its name, the fund's mandate allows the managers to search for overseas stocks with up to 30 per cent of the fund's assets. As of the end of 2000, the fund was taking nearly full advantage of its flexible mandate, leaving it with just 56 per cent in US stocks. The fund also had 12 per cent in Europe, and about 8 per cent in Asia-Pacific and other regions. Spectrum American Growth has a similar mandate to buy overseas stocks but as of December, it held less than 10 per cent in non-US stocks.
A question of value
Investing in value funds presents a similar situation. Though many money managers can generally be described as having a value approach, some managers have a more flexible definition than others of what constitutes a value style. In other words, just because a fund has the word "value" in its name, is it any assurance that value is what you'll get?
While there are few strict value funds investing in Canadian stocks, a value fund can generally expect to have a lower price-earnings (or P/E) ratio and/or a higher dividend yield - regardless of the "type" of value approach used. (Recall that stock prices are often quoted in relation to their earnings per outstanding share for comparison purposes.) YMG Canadian Value is an example where the "value" label could be questioned. Consider the following valuation characteristics for this fund (source: Morningstar Canada):
While not all value funds can be expected to be cheap on an absolute basis all the time, it is usually expected that a portfolio using a value approach should hold stocks that are cheaper than its benchmark index - in this case the Toronto Stock Exchange 100 large cap index. However, that's not the case with YMG Canadian Value.
If it's confusing fund categories you want, take a look at the mixed bag that makes up the Canadian dividend class. Dividend funds include strict common stock funds to more conservative funds heavy in fixed income (i.e. preferred shares). The problem is you'd never know which was which by looking at the names.
PH&N Dividend Income is a fine fund but one that couldn't generate much income if it charged zero fees. The focus of this fund is on common stocks (currently 94 per cent), and financial services in particular which make up about half of this fund. It's been a stellar performer over its history and I love the fund, but it's not one that will generate income.
By contrast, CI's Signature Dividend Income goes by a very similar name as the PH&N offering, but adheres to a very different strategy. Lead manager Eric Bushell works diligently to uncover quality preferred shares in a diminishing supply of such securities. Bushell holds about 43 per cent in preferred shares (which usually pay fixed dividends) and just 37 per cent common stocks. Though the names seem quite similar, the strategies are quite different.
The Signature fund's large fixed income component makes it behave more like a balanced fund, while the PH&N offering has no fixed income to smooth out the short-term dips. Both are terrific funds, but investors must beware before investing their money since each serves a different purpose.
As usual, my message this week is to never blindly trust "labels" and fund names since they are at least partly the work of marketing teams. In other cases, like dividend funds, fund names may have been accurate at one time but names didn't change with the times. In any event, don't assume a fund is what it appears to be until you do a bit of homework - whether it's on your own or with your advisor. The SEC's recently introduced regulation is a good step for investors. Let's hope Canadian regulators aren't far behind.
Dan Hallett, CFA, CFP is the President of Dan Hallett & Associates Inc. in Windsor Ontario. DH&A is registered as Investment Counsel in Ontario and provides independent investment research to financial advisors. He can be reached at firstname.lastname@example.org
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