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What’s New
Canadian ETF industry continues to grow – Investors continue to love their ETFs, as industry assets passed the $60 billion mark in May according to a report published by National Bank Financial. BlackRock’s iShares continues to be the dominant player in terms of assets, but it is BMO that is leading the charge in sales. The report estimates that BMO saw net inflows of over $1 billion in May, bringing their total AUM up to $12 billion. Despite the bump in yields, the report estimates that bond ETFs saw more than $800 million in new money, while equities gained $710 million, with global ETFs leading the way. In comparison, the ETF industry in the U.S. is estimated to be $1.4 trillion.
Mackenzie’s Fred Sturm hangs it up – After spending more than 32 years with Mackenzie, veteran manager Fred Sturm has decided to retire, starting August 31. Mr. Sturm headed up the firm’s Resource Team and has gained the respect of many involved in the industry, and was chosen as 2004’s Analysts’ Choice Fund Manager of the Year at the Morningstar Canadian Investment Awards. He will be replaced by Benoit Gervais, who has worked with him for more than a dozen years. Given the management process that is in place, I would expect that this will be a fairly smooth transition with minimal impact on investors.
Name changes for Harbour Funds – Staring in late July, the global mandates managed by CI’s Harbour Advisors are undergoing a rebrand. The Harbour Foreign Equity Corporate Class Fund will be renamed to the Harbour Global Equity Corporate Class, while the Harbour Growth & Income Corporate Class Fund will become the Harbour Global Growth & Income Corporate Class. According to the press release, CI is making this change because they feel that the new names better reflect the funds’ go anywhere mandates. There will be no changes to the mandates or the fund codes.
Late Surge in Yields Pushes Bonds Lower
By Dave Paterson, CFA
Bernanke’s comments on tapering bond buying program spooks investors
Watching CNBC and BNN, you would think that the end of days was upon us. Stock, bond and gold markets have tumbled in unison and many investors are running for the hills. One word – relax. It’s summer. Let’s take some time to look at this all rationally.
I think a lot of the last few weeks have been an overreaction to the true situation. U.S, Fed Chairman Ben Bernanke only said that he will be slowing down bond purchases (which we already knew) and would base that slowdown on economic statistics (which we already knew). The only thing that sort of came as a surprise is that he expects to meet the thresholds sooner than he had originally expected – later this year or early next year instead of next year or later. He also reiterated that even once they stop buying bonds, rates will still remain on hold for a while. So really, I don’t get the panic.
Looking at the bigger picture, economic fundamentals in the U.S. are on the rebound. Housing is doing well, and consumer confidence is strong and gaining strength. Granted, it’s a long way from generating big job numbers or anything close to having the economy running at full capacity, but it continues to move in the right direction. In Canada, it’s less of a rosy picture, so rates here are more than likely on hold for even longer.
Another thing that has been pointed out is that it’s an odd time in that equities, fixed income, and gold have all dropped at the same time. Some have even suggested this is a new normal. I don’t think so. I see it as more of a short term reaction to all the liquidity in the system. For the past few years, many equities have traded more on overall market liquidity than company specific fundamentals. With traders being told the tap was being turned off sooner than they thought, many panicked and sold out their positions.
Bonds were hit because many feared that short term interest rates would rise, pushing up the yield curve. This caused some traders to sell, which encouraged others to sell and so on. Gold was sold down because with the prospect of less liquidity in the system, the outlook for inflation has been further reduced. Looking ahead, I fully expect that equities will return to trading on fundamentals again, and honestly, those fundamentals aren’t too bad. Bonds and gold will return to doing what they do, so that historic negative correlation profile is expected to return to normal soon.
Still, we’ve known that rates were going to move higher for a while. That’s why I’ve been telling anybody who will listen that they need to diversify and reduce the traditional bond exposure in their portfolios. This including my suggestion to move into corporates, shorten duration and go global when you can. In my Recommended List, I pulled Dynamic Canadian Bond Fund and replaced it with Dynamic Advantage Bond. The managers are more active in adjusting its duration, and it has a much broader asset allocation than the Dynamic Canadian Bond Fund.
I’m also considering recommending a shift into PH&N Total Return and TD Canadian Core Plus Bond over the current funds on the Recommended List, again, because they have more flexibility to play defense in a rising rate environment. I also continue to recommend Manulife Strategic Income and recently added RBC Global Corporate Bond. I think these funds will hold up very well, at least on a relative basis going forward. They both have relatively short durations and offer a much higher yield profile than a pure Canadian bond fund. They are also actively managed, and currency exposure is hedged.
I like floating rate funds, but you can only use them for a portion of your fixed income exposure. It’s all pretty much unrated debt (although most is secured), but it’s more risky than it looks on the surface. Take a look at how they got slammed in 2008, dropping as much as many equity funds did. In the floating rate space I like Trimark’s Floating Rate Income Fund. It’s probably the most conservative. I don’t mind the Manulife offering, but have noticed that it is one of the most volatile in the category. You’ll probably get decent returns out of it, but it will likely be a bumpier ride.
I expect that in the near term, real return bonds are going to continue to be sold off. With the threat of inflation largely contained, I reckon they will trade like long-term bonds. With upward pressure on yields, we’ll see continued downward pressure on prices. It’s a pretty tough time to justify having much, if any exposure to these in a portfolio right now.
Regardless, I think the past couple of weeks likely represent a turning point. That doesn’t mean we need to panic. In fact, now it is probably most prudent to not do anything rash, and keep focusing on disciplined portfolio construction. Volatility is likely here to stay in the fixed income space for the near term, and equities will remain volatile. A good asset mix can be a strong defense through this, but unfortunately some losses are going to happen.
We knew this day was coming, and I think this is just a preview. Hopefully the traders will get it out of their system and rationality will soon return to the markets. Until then, enjoy the summer!
If you have any more specific questions, please do not hesitate to contact me.
Time to Rethink Fixed Income
By Dave Paterson, CFA
Recent spike in yields just the beginning, more pain to come
Over the past few weeks, bond yields have moved sharply higher, causing many fixed income investors to see something they haven’t seen in a while, steep losses. The yield on the benchmark Government of Canada ten year bond has moved from 1.67% on May 2 to a high of 2.55% on July 5. During that same period, the iShares DEX Universe Bond ETF (TSX: XBB) sank by more than 5%.
Causing this spike in yields were comments made by the U.S. Federal Reserve Chairman Ben Bernanke that he would be looking to slow down and eventually bring to an end their massive bond buying program, which currently buys up to $85 billion a month in U.S. debt. Markets took these comments to mean that it was just a matter of time before they removed the massive amounts of stimulus from the economy. What I think got lost in his comments was that the slowdown would be dependent on two key factors, a significant drop in the unemployment rate, and a jump in inflation. Looking at the economic data, it may be a while before either of those thresholds is met. Further, even if they slow or stop the bond buying, they are still a long way away from raising their key overnight Fed Funds rates from its current low of 0.25%.
For the past year or more, I have been somewhat concerned about the fixed income exposure in a number of portfolios I have looked at. While I wasn’t expecting an increase in yields as quick or as severe as we did, I was still concerned that investors were putting too much money into fixed income and yield focused products. I have favoured equity over fixed income for some time, and within the fixed income space, had suggested that investors shorten duration, increase yield, and favour corporates over governments.
I stand by this. While the temptation may be to sell your fixed income holdings now, I would strongly suggest that instead, you tread carefully. Despite the big losses in the past couple of months, fixed income will always have a role to play in your portfolio. Fixed income, particularly government bonds, has historically shown a negative correlation to equities. I fully expect that in time, that relationship will continue. The biggest difference now is that for the past thirty or so years, yields have been on the decline, while going forward, they will be on the rise. This will result in downward pressure on the price of bonds, meaning that it will be increasingly difficult to generate big returns from your bond investments. Instead, you should look for your bond holdings to help reduce overall risk in your portfolio. They will zig when your equity holdings zag, providing you with a smoother overall ride in the end.
Still, there are ways that you can protect yourself against further rate rises. They include:
1.) Shorten Duration – This involves investing in bonds that have a term to maturity of less than five years. The shorter the term to maturity, the less interest rates affect the price of the bond. For example, while the DEX Universe Bond Index was down nearly 5%, the iShares DEX Short Term Bond Index Fund dropped by 1.7%.
2.) Increase Yield – Perhaps the best way to do this without taking on a lot of extra risk is to invest in high quality corporate bonds. Typically, they pay a rate of interest that is higher than a government bond that has the same maturity date. This is important because the higher the yield that a bond pays, the less it will be affected by increases in yields. You could venture out into the riskier “high yield” spectrum, which is fine for a portion of your fixed income investments, but you need to be aware that they can be almost as risky as equities.
3.) Go Global – The prices of bonds tend to trade based on the yields offered in their regions. For example, Canadian bonds trade based on the yields offered in Canada. Because of this, there are opportunities to find fixed income investments that will not be as impacted as Canadian bonds. One of our favourites has been the Manulife Strategic Income Fund. During the past few weeks, it was down only 2.7%, handily outpacing the Canadian bond market. One tip, make sure that the fund’s currency exposure is hedged, at least partially, otherwise the volatility can become quite extreme, particularly for a bond investment.
4.) Stay Active – It is environments like these where active managers should earn their keep. While a passive ETF may provide low cost exposure to a fixed income market, active managers have more tools at their disposal to help manage risk and better protect the downside. For example, Michael McHugh, manager of the Dynamic Advantage Bond Fund has been actively shortening duration in his fund and increasing yield where possible. As a result, while the broader markets were down nearly 5%, his fund was down 3.3%. The trend also held with many of our other favourite actively managed bond funds including TD Canadian Bond and PH&N Total Return Bond, which both held up better than the index. I expect that this trend will continue and as long as yields remain choppy, active funds should outperform index funds.
5.) Floating Rate Notes – These are interesting investments that pay a coupon rate that is tied to the general rate of interest. When rates rise, so too do the coupon payments that investors receive, which effectively eliminates the risks of rising yields. While this may sound appealing, the reality is that many of these notes are issued by some pretty small companies. While a lot of them are secured, there is still a risk of default that will be higher than with other types of bonds. Still, adding some exposure to these types of bonds can be beneficial.
Bottom Line: While the recent jump in yields wasn’t a surprise, the timing and pace with which it happened was. While you may be tempted to sell all your fixed income holdings, I would instead suggest that you rationally pull back your exposure where possible, and take some of the steps listed above to help try to protect yourself against further increases in yields. I fully expect that the near term will see levels of volatility in the bond markets that we haven’t seen in a long time. Still, bonds can play a key role in your portfolio by helping to keep your overall level of volatility in check.
PH&N Short Term Bond & Mortgage Fund (PHN 250) – In the short term bond space, this fund is consistently at the top of my list. It is a mix of high quality, short term corporate and government bonds and mortgages. All the holdings are investment grade, and the duration is relatively low at 2.3 years. It will still get hit when yields move higher, but much less so than a traditional bond portfolio, with a longer duration. It is also quite reasonably priced with an MER of 0.61% for the Series D units.
Dynamic Advantage Bond Fund (DYN 258) – For a traditional bond fund, this is fast becoming one of my favourites. Managers Michael McHugh and Domenic Bellissimo are very active in overseeing the duration of the fund, which is currently 4.7 years. That’s much less than the DEX Universe Bond Index. It is also significantly underweight in government bonds, with more than half the fund is invested in corporate and high yield. This is also a great pick for investors in taxable accounts as it is also available in a corporate class version.
Manulife Strategic Income Fund (MMF 559) – If you’re looking for global fixed income exposure, this is my pick. This tactically managed global bond fund provides exposure to a number of different types of fixed income investments including high yield bonds, investment grade corporate bonds, global and emerging market debt, U.S. treasuries, and Government of Canada bonds. Currency is tactically managed. The fund’s duration is lower than the DEX Universe Bond Index, and its yield is higher. It has shown low levels of correlation to the other main indices, which makes it a nice diversifier when used in a portfolio. The biggest drawback is that its cost is a little high at 2.10%.
RBC Global Corporate Bond Fund (RBF 580) – This is another great global bond offering that is focused on the corporate bond sector around the world. While it can invest up to 30% in high yield and emerging market debt, the credit quality of the portfolio is rather high. Its duration is below the DEX, and its yield is higher. From a volatility perspective, it has been slightly above a comparable Canadian focused bond portfolio. Currency exposure is fully hedged and costs are quite reasonable, with an MER of 1.74%.
Trimark Floating Rate Income Fund (AIM 1233) – As mentioned above, floating rate notes can be a great addition to a portfolio in a rising yield environment. This is our top pick in the space. It is the oldest fund in the category and has delivered modest longer term returns. It has also been the least volatile. It was hit hard in 2008, dropping by 27%, but has since more than made up for that decline. We believe that it should continue to be the leader in the space on a risk adjusted basis, although there may be one or two others that may do better on an absolute basis.
Real Estate Funds Hit Hard on Rising Yield Fears
By Dave Paterson, CFA
Drop in values creating attractive valuations for long term investors
With bond yields skyrocketing in recent weeks, bonds were hit hard, suffering significant losses with the DEX Universe Bond Index dropping by more than 2% in June. While the bond market took a hit, so too did all the interest rate sensitive sectors including pipelines, utilities, and real estate.
In June, the iShares S&P/TSX Capped REIT Index (TSX: XRE) plummeted by more than 6% and has fallen more than 11% since April 30. The more diversified BMO Equal Weight REIT Index (TSX: ZRE) has fared slightly better, dropping 10.9% since the April 30 peak. Both have rebounded since their June 24 low.
The fact that REITs experienced a selloff should not be surprising to most. They have been on a very strong run since March 2009. Even taking the recent pullback into account, the REIT index has grown by more than 150%.
Recently, I had the opportunity to sit down with Vikash Jain, the Chief Investment Officer of Morguard Financial Corporate, and Derek Warren, a portfolio manager with the firm, who is responsible for the CIBC Canadian Real Estate Fund (CIB 506) to talk about the state of the real estate market in Canada.
Despite the recent selloff, both remain positive on the outlook for Canadian real estate for the medium and long term. They believe that institutional demand for high quality properties, combined with retail investors’ demand for yield will provide longer term support.
Shorter term, however, they believe that the high levels of volatility are likely to continue. While the selloff has been somewhat harsh, it is their view that it is in line with expectations, given the extent of the jump in yields. Historically, the yields offered by REITs have been within a fairly tight range compared to the yields offered by Government of Canada bonds. Even with the selloff that range has held. This leads them to believe that what we are experiencing is not an issue with real estate, but is instead a wholesale re-pricing of all yield generating investments.
While some may be tempted to look at the current situation as a repeat of what happened in 2008, Mr. Warren doesn’t believe this to be the case. He points out that since 2008, many real estate companies have reduced their total debt load, and have used the low rate environment as an opportunity to refinance, which has reduced their overall interest costs. Combined, these factors put many real estate companies in a much stronger financial position than they were a few years ago, which will allow them to withstand any slowdown much better than they could have before.
Still, with much uncertainty regarding the near term direction of yields, more volatility is expected and a further pullback is likely. There can be benefits to the drop in share prices. It will likely result in many REITs buying back their own shares. According to Mr. Warren, Boardwalk REIT just announced that they are planning to buy back up to 10% of their outstanding shares, and more REITs are expected to follow suit.
Another shift that they expect to happen is investors who have long thought of REITs predominantly as yield vehicles may soon start to see them as good growth opportunities. They expect that this is likely to happen when we see the yield on a ten year Bank of Canada Bond trading in the 2.75% to 3.50% range. At those levels, they believe that the total returns offered by many REITs and real estate companies will be above 7%, which begins to look very attractive to a lot of investors.
Further providing support to the sector is the huge demand from institutions for high quality real estate. With many pension plans needing to generate cash flow to satisfy their monthly payment requirements, real estate is a great way to do that. With REIT values being pushed down by the higher bond yields, it provides an attractive entry point for a number of pension plans. Mr. Warren expects to see many institutions taking significant positions in a number of REITs, and it is even possible for a number of REITs to be taken out completely. Morguard recently sold a portfolio of industrial properties for much higher than the asking price. There were seven bidders, all of which were pension plans looking to add real estate to their portfolios. While lower grade properties will suffer, there is still tremendous demand for high quality real estate.
Bottom Line: With continued uncertainty on the short term direction of yields, more volatility is expected in the real estate sector. It is likely that as rates move higher, we will see continued pressure in the sector, pushing prices down. As this happens, retail investors’ demand for yield and institutional demand for high quality properties will provide some level of support for the medium and long term. I suggest that investors hold off on making new investment at the moment, and start buying on the dips.
My Top Real Estate Picks
BMO Equal Weight REIT Index (TSX: ZRE) – This ETF is designed to replicate the Dow Jones Canada Select Equal Weight REIT Index, net of expenses. The index will generally hold 20 of the biggest REITs in Canada. It carries an MER of 0.62%, which is slightly above the iShares S&P/TSX Capped Composite Index ETF (TSX: XRE). Still, I prefer the BMO offering because I believe it offers better diversification. XRE holds only 14 REITs, with RioCan and H&R REIT making up more than 35% of the portfolio.
CIBC Canadian Real Estate Fund (CIB 506) – Managed by Derek Warren of Morguard since December 2012, this mutual fund invests in a mix of REITs and real estate operating companies. Using a bottom up, value focused approach, the portfolio is made up of high quality, well managed companies that are trading at an attractive valuation. It is fairly well diversified, holding approximately 50 names. Performance has been decent and volatility has been slightly lower than its peer group. The fund is tiny, at just over $68 million, which gives the management team a lot of flexibility. It does not pay a monthly distribution, which might make it unattractive for those looking for cash flow. Another drawback is that it is fairly expensive, with an MER of 2.95%. Still, it is one of the better choices for a pure real estate fund in Canada.
Sentry REIT Fund (NCE 705) – By far the largest real estate fund in Canada, it, as the name suggests, invests in REITs. While the focus has historically been in Canada, currently about 30% is invested abroad, with the U.S. being the main foreign exposure. It is well diversified holding around 50 names, with the top ten making up around 40% of the fund. It pays a monthly distribution of $0.0833 per unit, which at current prices works out to an annualized yield of approximately 8.6%. Looking at the underlying portfolio, this level of payout will result in some level of capital erosion, unless they can generate some capital gains. Performance has been decent and volatility has been respectable. It is a good choice for those looking for real estate exposure while at the same time generating cash flow. It is also not a cheap offering, with an MER of 2.73%. Our biggest concern with this fund is its size. It is significantly larger than many of its competitors combined, which may begin to affect the manager’s ability to generate yield going forward.
Are You Paying Too Much For Your Mutual Funds??
By Dave Paterson, CFA
Understanding the costs helps you not get ripped off
With all the media hype surrounding the high cost of mutual funds in Canada, many investors naturally assume that they are being ripped off. The reality is that yes, fees are high, but there are many other factors to consider before we can say with certainty that you are being taken to the cleaners. For example, the biggest determinant would be whether you are working with an advisor, or investing on your own.
Before we answer the question of whether you are being ripped off, let’s take a deeper look at the total cost of a mutual fund. Often times, this is referred to as the MER, or management expense ratio. The MER is really a mix of four different components: investment management, dealer compensation, operating expenses and taxes.
The investment management fee is paid to the portfolio manager and is intended to cover the cost of running the portfolio. Quite often, the more involved the process, the higher the investment management fee. This is one of the reasons why a number of specialty mandates, for example emerging markets or healthcare, tend to be more expensive than broader equity mandates. It is more costly for the investment manager to conduct their research and in some cases, it can be quite expensive for trade execution and custody costs. This also helps to explain why bonds and money market funds tend to be less expensive than equity funds.
The next component of the MER is dealer compensation. This is an annual commission known as a trailer fee that is paid to your advisor’s firm to compensate them for providing you with investment selection and financial planning services.
The third component is the operating expenses of the fund. This includes charges that go beyond the investment management costs and covers such things as legal fees, audit costs, printing costs, and other similar type expenses. Over the past several years, a number of fund companies have switched to a fixed administration fee instead of having the funds pay the operating costs directly. The jury is still out on whether it is good for investors but it does provide cost certainty where just paying the operating costs can result in fluctuations on a year over year basis.
The final component of the MER is the taxes that the fund must pay on the various other components. Because investors live all across Canada, the fund companies have the option to pay a blended rate of HST, based on residency. This allows the fund to pay a rate that is less than the 13% they would have to pay if they were required to pay the HST based on the fund company being located in Ontario.
To get an idea of how this looks on a specific fund, I broke out the MER of the front end version of the CI Harbour Fund (CIG 690). With an MER of 2.43%, it is right in line with most other Canadian focused equity funds. Its breakdown looks like this:
| Cost |
|
| Investment Management Fee |
1.00% |
| Dealer Compensation |
1.00% |
| Operating Expenses |
0.20% |
| HST |
0.23% |
| Total |
2.43% |
This is not meant to be an indictment on the quality of the fund. I believe that it is a high quality, well-managed fund that over the long term has the potential to outpace the broader market, and do so with less volatility. It remains on my recommended list.
When compared to the 0.25% MER of the iShares S&P/TSX Capped Composite Index (TSX: XIC), this cost is outlandish. Still, to say unequivocally that you are being ripped off is not as cut and dried as it may appear on the surface. There are other factors to consider.
For example, if you are working with a competent advisor, every year they should be having at least a meeting and a couple of phone calls with you to discuss your portfolio and financial situation. They also will review your account internally on a quarterly basis, if for no other reason than to keep their compliance department and the regulators happy. They will be spending at least a few hours on your account over the course of the year.
If we look at it as we would any other professional relationship, advisors are entitled to earn a fee for their time. Many professionals I know charge at least $100 an hour, and often much more. On a $50,000 account, the dealer receives $500 in trailing commissions, which means that your advisor must spend around five hours each year focusing on your account. If you consider preparation time, paperwork, and meeting time for the advisor and staff, you can see that it is not difficult for them to spend at least five hours on your account over the course of a year. This helps provide a level of value for the service you receive.
If you are unhappy with the fees you pay, but want to continue working with your advisor, you have options. One way is to negotiate the fees you pay by investing in a “fee based” type of account. Here, the advisor will put you in “F-Class” funds which are regular mutual funds, but have the dealer compensation portion stripped out of the cost. The result is a fund that costs about 1% less than a typical fund. You advisor may also suggest you invest in the lower cost exchange traded funds (ETFs) to help keep total costs down. In these cases, you and your advisor can negotiate the fee you pay them, and you will be responsible for writing a cheque each year. The upside of this is that it may be tax deductable, although I would definitely check with a tax expert before claiming such expenses.
On the other side is that if you are a do it yourself investor, using a discount broker to invest in mutual funds, then yes, you are definitely being ripped off. By buying a fund through your discount broker, you are being charged 1% for a service you are not receiving – namely financial planning advice. Based on a $50,000 investment, your discount broker is earning $500 each and every year and providing you nothing but order execution and custody.
What are your options as a do it yourself investor looking to cut costs? The first one is pretty obvious, and that is to invest in ETFs rather than mutual funds. You will get a comparable investment exposure for significantly lower costs. Still, you will have to pay a commission to buy and sell an ETF, as well as other potential costs such as a wide bid/ask spread, account fees, or in some cases custody costs. While I fully expect that the total costs will still be less than with a similar mutual fund, you will want to fully understand what costs you may have to pay.
If you are a do it yourself investor who still likes high quality, well managed mutual funds, there are a few great “no load” options available to you. A couple of the banks, namely TD and RBC, offer some low cost index funds that on a total cost basis can compete nicely with ETFs. They can often be bought and sold with no commissions or fees through your bank or their discount brokers.
There are other fund options available too. A number of fund companies prefer to deal directly with the individual investors, offering their funds on a no load basis. A potential drawback to this approach is that you will likely have to put up a higher minimum investment in each fund, typically between $5,000 and $10,000. You may also be subject to a minimum account size. Some companies to check out would include Steadyhand Investments, Mawer Investments, Beutel Goodman & Company and Leith Wheeler Investment Counsel. Each of these firms offers a fairly wide selection of high quality, lower cost funds that can be accessed directly.
Bottom Line: If you are a do it yourself investor using the services of a discount broker, you are likely paying far too much for your mutual funds. You are better off investing in ETFs or dealing directly with a select group of high quality, no load mutual fund companies. If you are working with an advisor, your costs may be higher, but if you are working with a competent person those higher costs should be offset by stronger financial planning, which should help you make up that cost differential over time.
Reader’s Questions
Q. I have held the Chou RRSP Fund for a number of years. What is your view of this fund?
A. I like this fund. Still, it is not something I would consider a core holding because it carries a lot more risk than some other funds that are available. Instead, I view this fund as a great addition to an otherwise well-diversified portfolio.
Portfolio manager Francis Chou follows a well articulated, value focused approach in the management of this Canadian small cap fund. He looks for profitable, well-managed companies that have solid balance sheets and strong cash flow generation, and are well positioned in their respective industry. Being a value manager, Mr. Chou pays particular attention to the price paid for a stock and is looking to buy $1 for $0.50.
His portfolios tend to be fairly concentrated. At March 31, the fund was fully invested, holding 15 equity positions. Given that the fund is built on a stock-by-stock basis, the sector mix is dramatically different from the index. It has nearly 71% invested in consumer services, 23% in materials, 4% in financials and 2% in technology. This can often result in a portfolio that is not only more volatile than the index, but it will go through periods where it will either significantly outperform or underperform its benchmark.
For example, between May 2007 and March 2009 the fund dropped by more than 55%, a loss from which the fund has just recently recovered. In 2009 and 2010, it rebounded sharply, gaining nearly 88%. It again struggled in 2011, losing nearly 21% during the year only to bounce back by more than 34% in 2012.
Long-term performance has been strong, gaining 8.4% annually for the five years ending June 30, handily outpacing the 2.6% rise in the S&P/TSX Completion Index during the same period. Still, it is our view that this is a fund that is only suited to those that have a fairly high tolerance for risk.
Along with being volatile, I have other concerns including key person risk. While I believe that Mr. Chou is a skilled manager, Chou Associates is basically a one-man show. If something was to happen to Mr. Chou and he was unable to continue managing this fund, investors would be negatively affected. For that reason alone, I would limit exposure within the portfolio.
Mutual Funds / ETFs Update
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