Where to invest in 2001

Forecasting the future is rather like betting on a horse race. We know the pedigree and the track record of each animal, but there is no way of predicting how the beast will perform on a given day. Even the favorites sometimes lose.

Mutual funds suffer from the same problem. We know the historic record and the management style. If economic events unfold as projected, we should be able to pinpoint the funds that will perform well over the next 12 months.

But the unexpected can happen, and often does. That’s why it makes good sense to maintain a well-diversified portfolio. Adjust your weightings so as to position yourself to take advantage of the most likely developments. But don’t go overboard in any one fund, asset category, or sector.

Looking ahead
With that caution in mind, let’s look ahead to the coming year. As things stand right now, here are the major economic forces taking shape:

• A slowdown in the North American economy. There appears to be a general consensus that growth will continue in Canada and the U.S. in 2001 and there will not be a recession (although the odds against that are shortening and the "R" wo is being used with greater frequency). However, most economists agree that the pace of growth will slow.

• No more interest rate increases. The U.S. Federal Reserve Board seems to have achieved its objective of reducing the inflation risk and taking much of the steam out of overvalued stock markets. Powerful chairman Alan Greenspan indicated in a recent speech that the Fed is becoming increasingly concerned about the slowing economy and rate cuts may be in the offing. The Bank of Canada will follow the Fed’s lead.

• A sober stock market.  The bursting of the Nasdaq bubble has driven much of the "irrational exuberance", to use Greenspan’s term, from the markets. Wounded investors are likely to be more cautious in the months ahead.

Re-think portfolio
Against this backdrop, the funds that should perform best in 2001 are likely to be quite different from those that churned out great returns from 1998 to the first quarter of 2000. For many people, that should mean a rethinking of their portfolio weightings.

Let’s look at some of the funds that should do well in the expected climate of 2001.

• Canadian equity funds. In 1999-2000 (until October), the Canadian stock funds that performed best were those that were heavily weighted towards high-tech stocks, particularly Nortel. We expect to see a modest rebound in the high-tech sector in 2001, now that many good companies are trading at more reasonable levels. But given the chastened mood of investors and the new concerns over profit levels and p/e ratios, we don’t expect to see the high-tech funds come roaring back with spectacular gains.

The best performers in the year ahead are more likely to be funds that are broadly diversified and are run by managers with proven stock-picking talent. They include:

• One that we especially like is AIC Diversified Canada Fund. For several years, everybody loved the AIC funds because of the great returns they generated. Their performance was mainly tied to two strategies: a strong emphasis on financial service companies and a commitment to the value investing approach of Warren Buffett.

When value investing took on a Dark Ages look in the go-go Nasdaq boom and bank stocks were pounded by rising interest rates and merger disappointments, AIC’s funds took heavy losses and investors fled.

But it’s a new day and AIC’s approach suddenly looks pretty sound again as we look ahead to slowing growth, sober markets, and the likelihood of declining interest rates. Most of the funds in the group appear attractive in these conditions but this is our number one choice because it offers better diversification than, for example, AIC Advantage II which is more heavily concentrated in financial stocks.

De-emphasize risk

• U.S. equity funds. The changed conditions that are expected to prevail next year call for a different type of management style than that used in the majority of the U.S. stock funds now on our Recommended List. We’re looking to add funds that take a value or GARP approach and de-emphasize risk.

One good choice is the no-load TD U.S. Blue Chip Equity Fund.  Here’s a value fund that managed to turn in above-average results even during the high-tech heyday. It is run by Larry Puglia of T. Rowe Price Associates, one of the most respected money management firms in the U.S. The portfolio is well diversified and risk is below average. Profits are not exciting but steady and the fund held its ground over the latest six months, gaining 4.5 per cent to October 31. Three-year average annual compound rate of return is 20.4 per cent.

• International equity funds. AGF International Value Fund is one of the best funds of its type, managed by the Charles Brandes organization out of San Diego. Like many value funds, it has enjoyed a renaissance in recent months, gaining 26.2 per cent in the half-year to October 31. This one should definitely be in your portfolio in the year ahead.

• Bond funds. If interest rates begin to fall next year, it will be great news for the bond markets. Returns on bond funds, which have lagged in most cases, will recover and we could see some double-digit advances. In these conditions, we like the Altamira Bond Fund.

Manager Robert Marcus uses a very aggressive style with this fund. It pays off when interest rates are dropping, but when rates rise the risk is high by bond fund standards. We expect rates to move down rather than up so if you’re willing to take on somewhat more risk than is usual with a bond fund, this is your play.

Abridged from Mutual Funds Update, an electronic newsletter edited and published by Gordon Pape. For a free three-month trial subscription: http://gordonpape.fifty-plus.net/FreeMFU.html