Avoid mutual fund traps

Sometimes the performance of a mutual fund portfolio can be improved simply by dumping something no longer doing the job originally intended.

Take a look through your holdings and see if any of these are candidates for the trash bin.

  • Segregated Funds:
Here’s a product that was hot a couple of years ago but now virtually stagnant. Many people rushed to buy seg funds because they liked the guarantee of principal they offer.

    However, most seg funds charge high management expense ratios to pay for that protection, which cuts into returns. In many cases, it’s an unnecessary expense.

    There is no reason, for example, to pay higher MERs to insure balanced, bond, and money market funds.

    It’s questionable whether it even makes sense in the case of conservatively managed equity funds, such as Ivy Canadian, which has a seg fund spin-off. You’re giving up half a point a year in return potential, perhaps more.

    <SROG>Why pay extra?
    The odds of a balanced, bond, or money market fund losing value over a 10-year period (the time it takes before the maturity guarantee kicks in) is so small as to be almost off the radar screen. So why pay for the cost of insuring it?

    If the only reason you bought the seg version was for the capital protection, you could be throwing away two-thirds of a percentage point of return every year if the management expense ratio is that much higher.

    Reassess your reasons
    Of course, there are other reasons to own seg funds, such as creditor protection, estate planning, etc. But if protection of capital was your main reason for buying, take a fresh look and see if it still makes sense.

    The bottom line: Seg funds cost more money. Make sure you’re getting value for your expense.

    • High MER Income Funds:
    While we’re on the subject of high MERs, take a close look at the fees being charged on all your fixed-income and money market funds. Some of the expenses on these funds are extremely high, especially in the context of today’s low interest rates.

    If you are paying more than 1.5 per cent for your bond funds, you’re paying too much (foreign bond funds are an exception because of the extra costs involved in managing them, such as hedging contracts).

    Your Canadian money market funds should not be charging more than 1 per cent in annual fees. If you’re paying more, look elsewhere. There are lots of them around.

    The bottom line: With interest rates still extremely low, high MERs eat up a proportionately larger percentage of the returns from these funds.

    Don’t accept that as inevitable. There are alternatives.

    Next page: Chronic losers

    • Chronic Losers:
    Most funds go through up and down cycles. But a few are chronic losers. Year after year, they turn in sub-par results. Yet people still own them. We can’t understand why.

    Take the Cambridge Balanced Fund, for example. This Sagit entry was a fourth quartile performer every single year from 1995-2001. That means it was always in the bottom 25 per cent of its peer group. Although it improved slightly in ranking in 2002, it appears to be back to the fourth quartile this year to date. Talk about futility!

    Trans-Canada Bond Fund from the same company shares this dubious distinction.

    Sagit is a small company, but big funds with prestige firms also can be dogs. Take the Mackenzie Money Market Fund. It has more than $400 million in assets, but has never been better than a third quartile performer since 1994.

    And most of the time it’s been in the bottom 25 percent or its category. If you own units in it, ask yourself why.

    It’s easy to see how your fund rates compared to others of the same type. Just visit the Globefund Web site at http://www.globefund.com. Call up the funds of your choice and click on the Quartile Ranking tab at the top.

    You’ll be able to pick out the chronic losers (and long-term winners) in a second.

    The bottom line: Don’t keep chronic losers in the hope they’ll turn around. They seldom do.

    Adapted from the May issue of Mutual Funds Update.