Back to the States

The past few years have been lousy ones for U.S. mutual funds. Even with a bull market on Wall Street, the surge in the value of the Canadian dollar has virtually wiped out any profits from U.S. equity funds.

Over the three years to July 31, the average U.S. stock fund gained only 2.8 per cent a year in Canadian dollar terms. In contrast, the U.S. dollar units of many of the funds averaged double-digit annual gains during the same period.

It’s no wonder that Canadians have been sticking close to home. The average domestic equity fund has returned better than 15 per cent annually over the past three years. Why go anywhere else?

However, things may be about to change. The Canadian resource boom appears to be topping out. The big run in small-cap stocks is over. The loonie is showing signs of weakness. It’s time to re-think your strategy.

The pros are certainly doing so. Mackenzie Ivy Enterprise Fund asked unitholders to approve a mandate change that would allow it to invest in the U.S. RBC recently received unitholder approval to expand the mandate of several of its funds to allow more U.S. and offshore content. Dale Harrison, hea of the Canadian equity team at Phillips, Hager & North, says the only good values now are in the States. Irwin Michael, who runs the high-performance ABC funds, has been steadily increasing the U.S. content in his portfolios. So has value manager Francis Chou in his Chou RRSP Fund.

If some of Canada’s leading fund managers are increasingly looking south, shouldn’t you be doing so as well? The time to catch the wave is when it is starting to build, not when it’s about to crest.

This is not to say investing in the U.S. at this time is not without risk. The American economy appears to be slowing, the housing market is in decline, and stocks may face some turbulence. However, an economic slowdown is likely to hurt Canadian resource stocks much more than blue-chip U.S. companies. Also, if commodity prices are hit, our loonie could drop in value against the U.S. dollar, reversing the trend of the past three years. So taking some profits here and doing some portfolio rebalancing wouldn’t hurt.

When you scan through Globefund‘s list of 558 U.S. equity funds, you may not see much that excites you. That’s not surprising, given all that has happened in recent years. But here are two U.S. funds that you should look at closely with a view to adding one or more to your portfolio. All results are as of July 31.

Chou Associates Fund. This fund has done very well for investors. The three-year average annual compound rate of return to July 31 was 11.3 per cent, more than triple the category average. Even more impressive is the fact it produced these results without the benefit of currency hedges. No matter what time frame you look at, this fund has done well. The 15-year average annual return is 15.5 per cent, placing it right at the top of U.S. equity funds that have been around for that long. However, be sure you understand that this is not your typical fund. The portfolio has a few well-known stocks like Berkshire Hathaway and DirectTV but most of the other names will be unfamiliar. Manager Francis Chou is constantly on the lookout for value stocks with a good margin of safety, which can sometimes lead him to unusual picks. Generally, they turn out fine but he isn’t infallible – his Global Crossing pick has lost a bundle. Still, on balance this is a fine fund. Minimum investment is $10,000. Rating: $$$$

Dynamic American Value Fund (Class). This is another fund that tends to fly below the radar (it has only $90 million in assets) but it’s a perfect fit for the current economic climate. The managers use a deep value stock selection process based on the principles of Dr. Benjamin Graham. The goal is to identify mispriced securities, trading at less than 60 per cent of intrinsic value. This contrarian approach often results in the purchase of unpopular companies but as long as they are fundamentally sound they qualify for inclusion. Current top ten holdings include BellSouth, Barrick Gold, Berkshire Hathaway, and Merck, the troubled drug-maker whose stock has been on the rebound recently. Recent results are outstanding with a three-year average annual compound rate of return of 12.1 per cent, more than triple the category average. The fund’s only major stumble was in 2002 when it fell 22.6 per cent, otherwise it is a consistent first or second quartile performer.

Be sure to talk to a financial advisor before making any investment decision.