Profit Hunters Club

ProfitHuntersClub · Site Admin Joined: 31 Mar 2006 Posts: 25

By Gordon Powers
October 23, 2007
You know how books have a table of contents that explains what's inside? Or, maybe you've bought some Lego that came with a diagram identifying every piece?

Well, the same isn't true of mutual funds. Quite often there, the product you buy is at odds with the description on its packaging.

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Portfolio concentration. The idea behind the strategy of concentration is simple: A smaller portfolio allows managers to concentrate their brainpower on only a few stocks so they'll make better judgements. While the average Canadian equity fund might hold 150 stocks, these offerings look at 30 to 40 companies and thus, much larger bets.

There's nothing wrong with focused funds. In fact, in one study, fund researcher Morningstar found that more than 80% of concentrated funds beat their more diversified peers in six of the seven possible equity fund categories. But, they're typically more risky than their peers.

No one owns just one fund anymore. In fact, using index funds, you can gain plenty of diversification at a low cost - which is why buying a concentrated fund can make sense, provided you understand what you're getting. Just remember: when a stock sours, it can do some serious damage in a focused fund.

Even stock-pickers who have done well in the past can crash and burn with a concentrated portfolio. But, with larger funds, your returns probably won't stray far from the market averages.

Some funds that typically make bigger bets than most include the Mackenzie Ivy Canadian, Chou RRSP and CI Harbour funds.

Sector exposure. You know that a gold fund is going to be brimming with mining stocks. But, what about a more broadly-based Canadian equity fund?

Many large funds load up on blue-chip stocks like those of the big-five banks or insurance companies. Again, there's nothing wrong with this since the financial sector has been a top performer for years now.

And, the fact that takeovers and consolidations have trimmed more than 100 company names from the benchmark during the past five years doesn't help. But do you want to have two thirds of your money in financial stocks? And, if you do, consider that you could actually buy the stocks yourself at a fraction of the cost.

You'll have to judge whether you're getting value for the fees you're paying if your fund is simply packed full of financial stocks.

Here's a breakdown of a few funds that have a fair chunk of money riding on the financial sector: AIC Advantage (79%); TD Dividend Growth (58%); BMO Dividend (56%); Mackenzie Maxxum Canadian Value (52%); CI Signature Dividend (50%).

Geographic exposure. It's no secret that the entire Toronto Stock Exchange accounts for less than 3% of world stock-market capitalization.

While heading outside Canada may enhance the choice of investments in a fund, it clouds the waters for those making asset-allocation decisions in a diversified portfolio. Frankly, with many Canadian equity funds, the geographic breakdown is becoming too much of a moving target to track.

Several funds, including those from conglomerates like CI Investments, AIM Funds, and AGF Funds, have recently changed their guidelines to allow managers to boost their foreign content considerably. And, although it hasn't paid off recently thanks to the dollar's rise, many managers have been taking full advantage of this new leeway.

AGF, for instance, now allows several of its Canadian equity funds, including AGF Canadian Real Value and AGF Canadian Stock Fund, to put slightly less than half of the portfolio outside Canada. Mackenzie Financial Corporation has done the same thing with its Ivy Enterprise Fund.

If you just go by the fund name, things can get a bit confusing. You'd be better off deciding how much you want to invest in Canada, and then use other funds to achieve the desired global diversification. Either way, check the composition of Canadian equity funds more closely. Right now, higher foreign content funds include the Trimark Canadian Endeavour, MD Equity, and AIM Canadian Premier funds.

Currency exposure. While heading offshore certainly expands the opportunities available, it greatly increases the exchange-rate risk at the same time. Several managers use hedging strategies to protect against currency risk. It's an expensive practice, however, and the decision to hedge varies from company to company, and even from fund to fund.

Franklin Templeton, for instance, doesn't hedge in the belief that in the long run, currency movements will balance each other out. But, fund groups like Cundill and Criterion generally do. And, companies like TD Asset Management now provide parallel lineups of regular and currency-neutral funds.

The question is, as the Canadian dollar's ascendancy over its U.S. counterpart continues, how much U.S. exposure do you really want? Now beyond parity, there's greater scope for the loonie to fall - but not necessarily anytime soon.

At least, when you look at U.S. equity funds, you know what you get. Consider, however, these global funds. Each has very high weightings in U.S. stocks, even though their moniker might suggest otherwise: Hartford Global Leaders (61%); Ethical Global Equity (55%); Brandes Global Equity (43%); BMO Global Equity (43%); Dynamic Global Dividend Value (38%).

Source: http://finance.sympatico.msn.ca/retirement/gordonpowers/article.aspx?cp-documentid=5612403