By Gary Norris
TORONTO (CP) – The virtues of mutual funds are well known and, especially at this time of year, heavily promoted.
Not so well known is the likelihood that a long-term investor could do better by buying stock in mutual fund companies than by investing in the funds they sell.
To put it another way, as the man in a Wall Street Journal cartoon tells Jack-in-the-Beanstalk: “This is better than magic beans, Jack. It’s stock in the company that makes the magic beans.”
Consider Canada’s largest fund operator, IGM Financial Inc. (TSX:IGM).
Its share price has more than quintupled during the past decade, producing compound annual growth of 18 per cent, not counting dividends.
Compare this with Investors Group’s best-performing fund with a 10-year record, Investors Summa C, which has a 10.8 per cent annualized return according to fund rater Morningstar Research.
Of the 28 other Investors Group funds in operation for a decade or more, only one has an annualized return over 10 per cent, and 20 are below seven per cent including three under zero.
Or look at CI Financial Inc. (TSX:CIX), a stock-market star with a 10-year annualized share-price gain of no less than 32 per cent.
That’s almost double the 16.9 per cent annualized return from its best-performing product over that period, the CI Global Opportunities Fund, which requires a minimum investment of $150,000. Just two other CI funds are in double digits over 10 years, according to Morningstar data.
Over the past five years, CI stock has risen an average of 12.8 per cent annually while IGM has advanced at a 15.8 per cent annual pace. Their three-year annualized gains are 38 per cent for CI and 24 per cent at IGM.
And these share-price increases don’t count dividends.
Fund managers charge fees to manage your money, but their corporate parents pay you to invest in their stock.
Current annual dividend yields are about 3.2 per cent at IGM and 2.7 per cent from CI.
“I’d rather be the owner of the fund,” asserts Fred Ketchen, director of equity trading at Scotia Capital, who has been working on Bay Street since the mid-1950s.
“I’m much happier watching the profits accrue to the mutual fund company shares, and participating that way.”
But the decision isn’t a no-brainer – and not just because of the convenience of investing in mutual funds and their provision of advice.
“When you buy an individual stock, anything can happen,” says Bill Holland, chief executive of CI Financial Inc.
Within its long-term uptrend, he says, “CI stock has dropped 50 per cent three times in the past decade and 60 per cent once.”
At AGF Management Ltd. (TSX:AGF.NV), the stock has a 22 per cent annualized return over 10 years while the best-performing AGF fund produced 12.7 per cent. However, that fund, AGF Canadian Resources, has gained 28.9 per cent annually in the past five years, while AGF stock is 16 1/2 per cent below its level of February 2001 amid a run of redemptions.
Of course, mutual funds can also lose money, and as Ketchen observes: “While your shares may go down, you don’t have to pay them 2 1/2 per cent or whatever their MER (fund management expense ratio) is to watch them go down.”
He adds that “you’ve got to do some homework” in any investment, including fund company shares.
“You’ve got to look back and see what their record has been, what their record of growth has been, take a look at the purchases-redemption ratios and so on, and all of that material is very vital, it seems to me, in determining which mutual fund company shares you want to buy.”
And past performance is no guarantee of future success.
The fund industry has enjoyed a terrific recent decade thanks to declining interest rates, generally solid financial markets and an aging population eager to invest, comments Rudy Luukko, investment funds editor at Morningstar Canada.
“It’s great for the investors that have held (fund company stocks) over this bullish period of the industry, but one can’t assume that over the future 10 years it’s going to be as rewarding a type of security to hold,” Luukko says.
Any individual company is hostage to ordinary business risks, regulatory action or the possibility of boneheaded executive decisions, and Luukko notes that over any period, volatility is far more extreme for fund company stocks than for diversified mutual funds.
“They’re not really comparable investments in terms of their risk-return profile, especially on the risk side.”
Tracking funds against fund company shares is “not really a relevant comparison – it doesn’t matter,” contends CI’s Holland.
“Those that are investing in mutual funds don’t want the risk of a single security – and rest assured, the risk of a single security is many, many, many times the risk of owning a basket of common stock.”
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