Wednesday, August 04

Duff Young

Saturday, July 31, 1999

"I
could do better than that" is something I'm hearing more and more today from investors frustrated with the performance of their mutual funds. Their motivation is predicated mostly on the negative attributes of funds, but in part they just think buying stocks seems like more fun.

On the negative side, they cite mutual funds' high costs, unfair taxes and the dubious value of active management. But while these feelings have long been common at the fringe, the difference today is the speed with which the trend is spreading into the mainstream.

Mutual fund sales are down 60 per cent year over year as of June 30, while the Toronto Stock Exchange 300-stock composite index is up 9.2 per cent so far this year.

Not that Canadian retail investors aren't buying U.S. stocks -- they are. But they're buying them individually, not through a fund.

The reasons behind the trend away from mutual funds are obvious. Funds can be dull. And awareness over performance problems is now widespread.

Fund investors, you see, haven't done all that well in the past four years despite the surging index levels.

If you're like most, you probably feel the frustration. It isn't so much that your funds have bombed -- they haven't. It's just that, well, you figured they'd do better. You buy funds to beat the market. Period. And these days, most don't.

This gap in expectations is exacerbated by today's unusual bipolar market action. At one extreme there are the few huge, hot stocks -- the half-dozen or so big-capitalization names whose explosive performance has, alone, accounted for an amazing 80 per cent of the market's return since last summer. But at the other extreme are the 290-odd names that are in something of a bear market.

Hey, high fliers like BCE Inc. and Nortel Networks Corp. make up a whopping 22 per cent of the TSE 100 Index. So very, very few active managers have even a market weight in the darlings of the day.

It's no wonder, then, that people are losing faith in active management. In many ways, I see their point. Maybe we should own a core set of big, blue-chip stocks just like the index -- something to buy and hold forever.

So why buy funds? They cost too much, compared with management fee-free alternatives like TIPs, which are exchange-traded units of the 35 companies that make up the TSE 35 index. Holding some of these will reduce your overall management fee burden when averaged over your whole portfolio -- a concept that's gaining more and more attention.

You only need mutual funds for two reasons: Diversification and professional management. So in areas where you need neither, lots of people are now choosing individual securities.

Beyond index baskets (like TIPs and their foreign equivalents) that trade like stocks, there are other ways to augment a mutual fund portfolio with individual securities. Domestic government bonds, for example, are fairly easy to pick and manage. Ditto for a portfolio of blue-chip preferred shares.

Or let's say you work in, for example, the medical device business. Why not research a few of your suppliers and competitors? You probably already know more about their business prospects than the Street -- so you can make good money while you learn and have fun.

Brokerage firms are catering to this crowd by offering defined portfolios of individual stocks, sold and tracked as though they're a single bundle. It's a hybrid way of giving people the benefits of individual stock ownership without the headaches of trading. And by packaging the stocks together, they're trying to be sure to sell stocks that aren't just good, they're good together.

If I'm right about these trends, mutual funds may find themselves relegated to the role of running only specialty, small-cap or global funds -- the areas where we need diversification and professional management. In fact, those are the areas where active management still reigns -- even in a tough environment like the one we're in now.

Duff Young is president of FundMonitor.com Corp., which offers an independent portfolio repair service
http://www.fundmonitor.com