investment research

Each year Odette and I complete a thorough review of the investments we use for You First clients. We cover the entire Canadian mutual fund spectrum and eventually narrow it down to a list we are comfortable recommending. There is much more to a fund then merely its rate of return. Here are some of the metrics we look at when assessing a particular investment:

Manager: Who runs the fund? How long has he/she been in the industry? What is their investment style? Are they by themselves or part of a team? Do they have a repeatable process? Do they have long-term track record of above average returns? A fund’s portfolio manager is one of the most important considerations.

Quartile rankings: Every mutual fund is placed in a category based on the assets inside the fund (ex. Balanced Fund, Global Equity Fund, Canadian Dividend Fund). This allows for a comparison of the fund within its peer list. Each fund in a category is ranked according to return and is assigned in one of four quartiles. A fund with a 1st quartile 5-year return means it has achieved returns in the top 25% of all funds in its category over the past 5 years. We look for funds that consistently achieve top 2 quartile returns.

Standard Deviation: How volatile is a fund? Standard Deviation measures the variation in a mutual fund’s returns. Here are two very basic examples:

• Over three years Fund A has returns of 8%, 10%, 6%. The basic average (I won’t go into the timing of these returns) of these three returns is 8%. The standard deviation would be 1.63%.

• Over three years Fund B has returns of 16%, 0%, 8%. The basic average (ignoring timing) of these three returns is 8%. The standard deviation would be 6.53%.

Fund A and Fund B achieved the same rate of return, but fund B was much more volatile. All other things being equal, fund A has achieved a better risk-adjusted return. We look for funds with low volatility and high risk-adjusted returns.

Fees: All mutual funds have a Management Expense Ratio (MER) which bundles in both the management firm and advisor’s compensation. For an equity fund the MER averages around 2.3% although more expensive funds can near the 3% mark. Although a lower fee won’t guarantee a higher return, there is a correlation between the two and we strive to use funds with average or below average MERs.

Concentration: A mutual fund can hold as few as 10 stocks, but there are also funds that have hundreds of holdings. We generally look for concentrated funds that hold around 20-50 companies. This is usually the sign of an active manager with conviction and studies have shown that mutual funds with concentrated portfolios tend to outperform.

Upside/Downside capture: This metric compares how a fund performs relative to its benchmark index. If Canadian Equity Fund A has a 5-year upside capture of 100% relative to Toronto Stock Exchange (TSX), it means it increased as much as the benchmark in that period. If it has an 85% 5-year downside ratio, it only decreased 85% compared to the TSX. Naturally we look for funds to capture as much of the upside with as little of the downside. This is another way of assessing risk-adjusted return. Successful managers love highlighting a good upside/downside capture ratio during their presentations.

A lot of work goes into our fall analysis.  It is essential to do an in-depth review every year but ongoing monitoring is also part of our regular work. You will be updated at your annual review meeting and contacted should any urgent changes are required during the year.