Debunking Mutual Funds

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Mutual funds are an investment vehicle that pools together investors’ money to buy a basket of companies stocks, bonds or other investments. The investor then receives units in the fund and participates in the proportional gain-loss of the fund.

Mutual funds can have very specific investment themes, like oil and gas or technology companies, or have very broad themes, like value or growth, in which the fund manager can incorporate any company that meets the criteria of the mandate. The fund manager charges a fee to manage the basket of investments called a Management Expense Ratio (MER), that reflects a combination of their compensation for the extensive research and monitoring required, along with all administrative and trading costs.

One of the myths surrounding mutual funds is that they are low risk, a “safe bet.” This notion is commonly derived from the fact that, for the most part, mutual funds do not produce the most compelling returns. This can give an investor the impression that they appear to be a safe bet for your money and a good option for putting the cash in your savings account to work.

Many investors tune out when the discussion turns to mutual funds. They view them as a boring bank product that doesn’t offer much in terms of price appreciation, but that, at the same time, won’t really hurt them. Both of these ideas are fallacies.

Since many investors don’t know where to start when presented with a list of funds labelled ‘Balanced,’ ‘Income’ or ‘Global,’ they usually invest in whatever their advisor suggests, which may not always be the best idea for them. For example, a fund mandated from an institution may not be offered up not because it is the best option, but because the advisor is required to sell to you their mandated product. This means that the clients’ best interests are not always being looked after.

There are many funds out there, some with highly experienced fund managers and strong performance, but many companies will have a handful of outperforming funds and many that don’t do much of anything.

Consider that inflation is at two per cent and that the MER fees for these funds are anywhere from two to three per cent. If you are getting a five per cent return, it hardly seems worth it for that one per cent to be invested in the first place with the potential for capital loss if the fund underperforms. The potential losses are real and so are the fees that can eat away at any gains you may receive

Don’t get me wrong – I am a strong proponent of mutual funds, but only ones that make sense. All investors have different risk profiles, and expected and required returns, but getting five per cent return from a mutual fund before fees does not make sense. There are other products with much lower risk profiles that can provide a similar return.

So what to do? Investors must seek out the best of breed funds, the best-in-class management teams, the best historical returns. Based on those three criteria, you will be able to avoid overlap and put together a strong portfolio of funds that complement each other. The potential for outperformance is there; you just have to find the right product mix.

Next time you seek advice, demand a little more information, and ask for some options that don’t have an institution’s mandate attached to them – or find an independent firm that helps to mitigate some bias and put clients’ interests first by offering the same compensation for all products.

 

Written for Vancity Buzz by Evan Davies, a registered Investment Advisor at Canaccord Genuity Wealth Management, a division of Canaccord Genuity Corp., Member Canadian Investor Protection Fund. The views (including recommendations) expressed in it are those of the author alone, and are not necessarily those of Canaccord. The information contained herein is drawn from sources believed to be reliable, but the accuracy and completeness of the information is not guaranteed, nor in providing it does the author or Canaccord assume any liability.

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