Keith Woolhouse
 

Could the unthinkable be happening? Are Canadians turning their backs on equity-based mutual funds in favour of investing directly in the stock market?

If so, and the trend continues, it could mean a wholesale shakeup in Canadians’ investment philosophy is underway. It may also help to explain why the benchmark S&P/TSX index is on such a tear.

For years, Canadians have poured their savings into mutual funds to the point where the rest of the world regards us as being among the most parsimonious and savings-conscious, traits which go hand in hand with being cautious and conservative. Or so we’re led to believe.

There are 46 mutual fund companies in Canada with a total of $544.5 billion in assets under management. That equates to $18,150 for every man, woman and child in the country. It’s an all-time high for the industry.

The Investment Funds Institute of Canada (IFIC) — the national association of the Canadian investment fund industry — reports that Canadians are saving as seldom before. Fund companies took in $1.9 billion in new sales in July, the highest figure for that month since 1998. That amount does not include reinvested distributions of $664.1 million. Year-to-date sales stand at $14.8 billion, the best tally for the first seven months of the year since 2001.

It’s clear that Canadians have heeded the advice of government and the mutual fund industry to save for the future and that they are doing exactly that. It seems, too, that investors have put behind them the crash of 2000 that decimated the savings of many invested in the high-tech industry.

But amidst all the good news, a disturbing trend has developed. Since April 2002, investors have shunned equity mutual funds. For 34 of the past 38 months, money has been pouring out of the Canadian and global equity funds at an alarming rate. What began as a trickle in July 2003 has turned into a torrent. With the exception of a couple of upticks in the first two months of 2004 and 2005, the height of the mutual fund season, more money has been withdrawn from equity funds than has been invested in them.

For a long while, the funds holding U.S. equities were immune to the withdrawal phenomenon. That changed in July 2004, when redemptions at the equity level accelerated. James Gauthier, mutual fund analyst at Dundee Securities, attributes the redemptions in this area to investors’ delayed reaction to the declining U.S. dollar that in the past 12 months has slithered nearly nine per cent.

“Equity fund flows continue to be the bane of the industry,” says Mr. Gauthier. “On a combined basis, the group saw $537 million head for the exits in July.”

The funds most exposed to the redemptions were Templeton Growth, AGF International Value and Fidelity International Portfolio. This trio leaked a total of $228 million in the month. Fourth on the list was AIC Diversified Canada, which saw an outflow of $61 million.

Unquestionably, the hardest hit over the past 12 months have been Canadian equity funds which, excluding reinvested distributions, are down 1,298 per cent and the foreign funds, down 1,234 per cent. In both instances, while new sales have been solid, they’ve been heavily outweighed by redemptions.

One has to wonder where the money is going. It evidently is not being transferred into balanced funds or into the dividend and income bracket, both of which have been standouts over the past 12 months with sales soaring 39 per cent. These funds are in keeping with a more measured and cautious investment style.

But that’s not the case here. IFIC tracks redemptions, where funds are folded and the money is withdrawn from the sector. Where it’s going is a question it cannot answer.

It may be that Canadian investors have regained their taste for the stock market and, having seen the benchmark S&P/TSX index jump 25.5 per cent in the past 12 months, have decided to throw a little caution and a few dollars to the wind.

It’s impossible to say, particularly as the mutual fund companies reported that gross sales, year-over-year, increased by 14.3 per cent.

There are 1,239 Canadian equity funds and they comprise 65 per cent of all funds, and until three years ago, this sector of the mutual fund industry was the biggest magnet for investors. That has changed dramatically.

This year’s numbers tell a different story, with redemptions exceeding deposits in all three equity sectors. Gross sales of Canadian equity funds have been $11.13 billion, while redemptions have reached $12.02 billion. Foreign equities have attracted $8.30 billion and redemptions are at $10.41 billion. U.S. equity deposits are $3.59 billion, and redemptions are $4.46 billion.

The picture is less bleak elsewhere, with the performance of balanced funds little short of staggering. Year-to-date sales are $15.31 billion and redemptions $7.96 billion. New sales in June and July were the highest since IFIC began tracking statistics in 1990. A total of $1.1 billion was invested in the group in July. Sales of mortgage and real estate funds are also on the rise.

“There’s no question that for the last couple of years, equity funds have been on the decline,” said Erwin Go, the IFIC’s manager of statistics, who is equally mystified about the ultimate destination of the money being withdrawn.

In a comparison of Canadian and U.S. investment styles,

IFIC confirmed the pattern this week: “While equity funds are back in favour for U.S. investors, Canadians have shied away from these investments. Canadians put their monies into more conservative funds such as balanced, bond and dividend and income funds.

“Balanced funds represented almost half of all sales of mutual funds in Canada in 2003 and 2004,” said Mr. Go. “At the same time, U.S. investors were heading back into equity funds. The difference between investors in the two countries is probably indicative of the more conservative nature of Canadians.”