Past performance may not be much of a basis for evaluating any mutual fund for future investment. As they say, “Past performance is no guarantee of future performance.” But past performance can be useful in comparing two or more funds — provided those funds invest in the same markets or market segments.
In each Planning Guide issue of Canadian Mutual Fund Adviser, we provide performance figures for our 40 Top funds ranked in well-defined categories.
We also group these funds in the suitability categories we’ve always used. These include “Very Conservative Canadian Stock Funds”, “Aggressive Canadian Stock Funds” and so on. These are our categories that describe the investor need we think each fund addresses.
Our performance ranking statistics are based on categories that describe a fund’s portfolio.
In the column to the right of each fund’s name in the Guide, you’ll find a category number. This number corresponds to a category name at the bottom of the final page of the Guide. Category one, for example, is “Canadian Focused Equity” funds. Portfolios of these stock funds are composed mostly of Canadian equities, but possess substantial foreign equity holdings too.
Category two singles out “Canadian Equity” funds that possess only small holdings of foreign equities. And number three describes funds with small-cap portfolios consisting mostly of Canadian small-cap stocks, along with substantial holdings of foreign small-cap equities.
Titles describe fund types
The titles of these categories, then, describe the nature of the fund in each category. And the ranking statistics in the columns that follow the category column can be used to compare each fund with those funds in the same category. Our Top-40 list includes funds from 17 categories.
But remember, we consider past performance, even as ranked in categories, as just one of many factors when we make our recommendations. We also consider the nature of a fund’s portfolio in terms of diversification, size and quality of companies, consistency of year-by-year performance, losses and volatility. We also look at the the dedication, track record and quality of portfolio management.
No fund can provide consistently top-quartile, low-volatility returns to investors. And no fund can show up in the top 10 per cent of its category without incurring the risk of occasionally showing up in the bottom 10 per cent. Our analytical bias is for consistency of performance in a fund’s category over the long term. That, if any, is the most reliable indicator of the future.
Look at volatility
When you consider a fund’s past performance, even in comparison with similar funds, it’s useful, where possible, to look at the past year by year.
A fund that gains 10 per cent in each of five years will be an entirely different investment from one that gains nothing for four years and 61 per cent in the fifth year. But these two funds would look the same on a five-year, compound annual return basis. And they would rank the same in the same category. The second fund, of course, would have a higher volatility ranking than the first.
Our volatility rankings are listed in the last column of the table pages in our Planning Guide. These rankings are based on the latest three-year standard deviation calculations for each of our 40 top funds.
Simply put, these rankings are based on a scale of one to 10. If a fund’s ranking is 10, then it’s among the most volatile funds in Canada. Mackenzie Canadian Resource and RBC Global Precious Metals, listed on the last page of the Guide under High Risk International Specialty Funds, are such funds.
Funds with lower numerical rankings, of course, are less volatile. So Mac Ivy Canadian Fund, listed on the first page of the Guide under Very Conservative Canadian Stock Funds, is the least volatile fund among our Top-40, with a volatility ranking of three. Funds ranked one are usually found in the money-market category.
OUR CURRENT THINKING
Notwithstanding the possibility of a sharp market correction occurring in the near term, we think the overall outlook for equities remains positive. That’s because global economic growth should continue to gradually improve this year, and again in 2015. That, in turn, should help corporate revenues and profits rise, thus lending support to equity markets.
One potential problem, however, is that many equity markets, after trading at significant discounts to fair value in the years following the financial crisis of 2008, now seem to be fairly valued. The S&P 500, for example, now trades at 17 times earnings, slightly above its average multiple of 16 since the 1950s.
Current stock valuations in the U.S. suggest that investors have priced the ongoing economic recovery into share prices. They’re no longer fearful about a relapse into the dark days of several years ago. Thus the market’s valuation multiple reflects more normal economic conditions.
There’s no reason to expect market multiples to continue to rise from here on in. It will probably be up to companies, then, to provide the major impetus for rising stock prices through the revenue and profit gains that typically accompany better economic times. Even so, these gains are likely to prove insufficient to drive stock-market returns like those the U.S. experienced last year.
STRATEGIES TO ADOPT
As economic conditions normalize, we recommend you continue to add to equities through a dollar-cost averaging program of purchasing equal dollar amounts of fund units at regular intervals, such as, say, once a month. That way you’ll be able to buy more units at a lower price if markets correct anytime soon.
Make sure that the bulk of your equity portfolio is invested in conservative, diversified, large-cap funds that invest in Canada and abroad. Canadian companies should benefit as global economic conditions, particularly those in the U.S., improve. Canadian diversified large-cap funds we like now include Franklin Bissett Canadian Equity, Mawer Canadian Equity and NEI Northwest Canadian Equity Funds.
For conservative foreign investing, we like Capital International – Global Equity, Mawer International Equity and Templeton Growth.
Typically, we recommend you plan on holding such funds for at least five years, to give them sufficient time to achieve the desired results. However, if you have a longer investing time frame of, say, 10 years, and a tolerance for higher risk, you may want to put a smaller portion of your portfolio in more aggressive funds such as Brandes Emerging Markets Equity.
This Mutual Fund Planning Guide goes out each month to subscribers of the Canadian Mutual Fund Adviser. It forms the basis of our approach to investing in mutual funds: build a portfolio based on your needs and your investment temperament, using a selection of the best funds available for Canadian investors. Above you’ll find our current thinking on where to put new money. It’s based on our assessment of current financial-market conditions. We include our recommended strategy to adopt under these conditions.
We’ve chosen 40 of our top funds from among more than 5,000 available Canadian mutual funds, based on the quality of their portfolios. Our recommended list is not static, and will change as we find better funds or as funds change in nature. We’ll alert you to additions and deletions. From time to time, Canadian Mutual Funds Adviser will recommend buying mutual funds not on this list. But this list represents what we believe to be the best mutual funds to buy in Canada this month.
Below are 13 of the 40 Top Funds.
Canadian Mutual Fund Adviser, MPL Communications Inc.
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