Clone funds cut your returns

If you are holding any clone funds in your RRSP portfolio, take a close look at them. You may be sacrificing part of your profits unnecessarily.

Clone funds are designed to get around the Federal Government’s controversial foreign content rules. When they first came out, they became an overnight success and Canadians poured billions of dollars into them.

No longer popular
Now, barely three years after Mackenzie Financial launched the concept in the spring of 1999, the flow of new money into the clones has virtually dried up.

There are two main reasons for this.

• The first was Ottawa’s subsequent decision to raise the foreign content limit to 30 per cent. (It was 20 per cent at the time the first clones were launched).
• The second was the onset of the bear market, which hit overseas equity funds especially hard.

However, thousands of people still have clone funds sitting in their portfolios. If you’re among them, see if it’s time to move out.

Check foreign content:
The first thing to check is your foreign content limit. If you’re under the 30 per cent maximum, why should you hd clones at all? They are only designed for people who want to push their foreign holdings beyond that mark.

Even if you’re at the limit, you can increase foreign content without clones simply by choosing domestic mutual funds that maximize their own foreign content allowance. A Canadian equity fund with 30 per cent foreign holdings counts 100 per cent domestic for RRSP purposes.

Check clone performance:
Second, compare the performance of any clone funds in your account with that of the underlying parent fund. In theory, the clones are supposed to generate results that are within about 0.5 per cent of the parent.

In practice, that has sometimes not been the case. Some companies, such as AGF, had a lot of problems with their tracking for a time.

In 2000, for example, the AGF European Equity Fund posted a return of 12.4 per cent, but the clone managed only 9.9 per cent. If the clones were working correctly, we’d never see spreads like that.

Next page: Higher MER charges

Higher MER charges
The situation has improved recently, but the fact remains that clones will tend to underperform the parent fund over time because of the MER differentials that exist in most cases.

To illustrate, the AGF American Tactical Asset Allocation Fund has an MER of 2.49 per cent. Its clone charges three per cent Management Expense Ratio (MER).

The bottom line: Unless there is a very good reason to be holding clones in your RRSP portfolio, move out of them. Every advantage counts in these tough markets.

Adapted from an article that originally appeared in Mutual Funds Update.