Niche strategy actually lost money for mutual fund investor

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Randy has very little to show for 18 years of contributions to one of the country's leading mutual fund firms. (JOEL SCHLESINGER / WINNIPEG FREE PRESS) Photo Store

Randy's portfolio

CONTRIBUTIONS FROM 1994 TO 2004

$30,394

PORTFOLIO AS OF DEC. 31, 2004

$32,561

PORTFOLIO AS OF JUNE 30, 2012

$33,042

ANNUALIZED RETURN SINCE 2004

0.18 per cent

TYPE OF FUNDS OWNED SINCE 1994:

• European equity fund
• Japanese equity fund
• E-commerce fund
• Asset allocation fund
• Canadian equity fund
• U.S. equity growth fund
• Pacific international growth fund
• Canadian natural resources fund
• Global science and technology fund
• Socially responsible investment equity fund
• Global equity fund
• Dividend fund

Randy has little faith in mutual funds, and for good reason.

The 52-year-old salesman recently broke off an 18-year relationship with one of Canada's leading fund firms after contributing more than $30,000 and earning next to nothing.

"I actually don't think I've made any money," he says. "It's ridiculous."

Randy started out investing with the company, buying only its name-brand funds.

"I've always been interested in mutual funds, and at the time, you saw some nice returns," he says. "I said 'Sure, I'll take a stab at it.'"

He started out small with $1,000 in contributions here and $500 there. But on average, over a decade, he invested a couple of hundred dollars each month in about 12 equity funds, such as an asset allocation fund, a European equity fund and Canadian resources fund.

"I did the dollar-cost averaging, and I did everything that was recommended, and I thought of myself being a little bit well-versed in stocks."

Not once was he advised to buy a fund other than those that invested in the stock market, and he invested more than three-quarters of his money in a non-registered portfolio.

"Finally, about eight years ago, I thought, 'This is crazy,' and I stopped contributing."

At that stage, he had contributed $30,394. Soon after he stopped contributions, he got a letter from his financial planner notifying him he had a new adviser. A couple of years later, the firm assigned Randy another adviser whose only advice came in early 2008: Move a few non-registered equity funds to his RRSP to get a tax refund.

One year later, his portfolio, which had been as high as $43,000 in late 2007, was back down to about $30,000.

When he dumped the firm to invest on his own this summer, his portfolio was worth $33,042.

Randy says he isn't looking for advice so much as a post-mortem on what went wrong so he won't repeat past mistakes.

Investment adviser Stephen Watson pored over years of Randy's statements and found several problems that would have made it difficult for his portfolio to earn money.

For one, he owned too many funds for the amount of money he invested.

Watson, who works with MGI Securities in Winnipeg, says Randy owned 10 funds as of the last statement he received from the fund company. But at various stages over the years, he owned a dozen.

"Most of the funds are specialty products such as global science and technology, Pacific international, Japanese equity, a socially responsible," says Watson, an economist and former director of taxation analysis with Manitoba Finance.

"It appears they were picked in the hopes of striking a big winner, but if you only have three per cent of your portfolio invested in a fund that outperforms, the impact on your overall return will be negligible."

So while any number of his funds did well over a given time period, there were others that did very poorly, erasing those gains.

Many of the funds that did the most damage to his capital were flavour-of-the-day, sector-specific investments, such as an e-commerce fund purchased at the height of the tech boom.

Furthermore, almost all his funds were those that invested only in the stock market.

"Most portfolios should have some proportion of fixed income, which generally reduces the overall volatility and the risk of loss for the portfolio because it offers diversification into a different asset class," Watson says. "And it provides steady interest income."

Certainly, a fixed-income component to his investments would have helped Randy offset losses in the stock market in the last 18 years.

Going forward, Watson says Randy should consider investing in equity income funds as well as bond funds. Income equity funds invest in stocks that pay dividends, and investing for dividend income has a long track record of providing positive returns, he says.

"There is no law of nature or markets that says the price of any given stock or any selection of stocks has to go up over time, but strong companies that pay dividends tend to continue paying those dividends," says Watson, who builds portfolios of individual stocks and bonds as well as mutual funds for clients.

Had Randy invested in just two funds -- a dividend fund and a bond fund -- during the last two decades instead of a cornucopia of exotic equity funds, he would have been rewarded fairly handsomely.

Because Randy had contributed varying amounts of money to his portfolio until the end of 2004, and prior to that date the fund company had collapsed and merged a number of funds he owned, Watson says it's very difficult to "back-cast" with accuracy all the way to 1994.

"So let's assume Randy had, in December 2004, put 60 per cent of his money into the equity income (dividend) fund and 40 per cent into the bond fund," Watson says.

At that time, he would have had $32,500, with $19,500 in a dividend fund and $13,000 in a bond fund.

As of October this year, the equity income fund has increased 109 per cent while the bond fund increased 13.5 per cent. That's about a seven per cent annual return on his investments, and his portfolio today would be about $55,500 after fees.

Randy's actual portfolio, in contrast, earned about 0.18 per cent a year since 2004, and after accounting for inflation, he actually has lost money. If his portfolio had kept pace with inflation, it would now be worth $37,843 -- not $33,042, its closing balance at the end of June.

"Now, you might say that I have simply cherry-picked funds that worked with the benefit of perfect hindsight," Watson says.

But Watson says he chose two funds managed by the company that Randy had invested with for the last 18 years.

"I do not use this company's funds for my clients and I am generally not familiar with their offerings," he says. "I simply looked for one of its equity income funds and a bond fund, since this is close to the approach I use with my own clients who hold mutual funds."

Watson says the point he's trying to make is Randy didn't need a complex strategy involving several niche funds.

"Could Randy have done better using just this company's funds? Yes, he could have," says Watson, a board member of the Civil Service Superannuation Board, the province's largest pension fund.

But there's no sense mourning lost cash. Randy needs to focus on the future.

As he moves closer to retirement, he needs to manage the risk to his savings, and a balanced portfolio of just a few funds is a much better strategy to accomplish that goal than one that requires investing in several funds in many sectors.

"Simplicity is a great virtue in investing," Watson says. "Individual investors following a simple approach often do as well as or better than even hedge funds following highly complicated strategies."

giganticsmile@gmail.com

Republished from the Winnipeg Free Press print edition October 13, 2012 B11