Global income funds are hot

Global income funds are hot! New entries are appearing almost weekly as the major fund companies rush to grab a share of what they perceive to be the latest big ticket item.

A look at the statistics shows why the industry is so excited about this concept. Over the year to Feb. 28, assets in global and international equity funds increased by more than 31 per cent according to figures from the Investment Funds Institute of Canada (IFIC). Global balanced funds did even better, increasing 32.6 per cent. The two categories currently account for $173 billion in total assets (out of a total of $680 billion for IFIC members) and are growing much faster than domestic funds.

There are several reasons for this. The reversal of the Canadian dollar, which rose steadily from 2003 to mid-2006, has eased investor concerns about putting some of their money abroad. Also, many people have realized that their portfolios were overweighted in Canada and underweighted in international funds and have taken steps to diversify.

But why global income funds? That picks up on another trend, the growing demand for cash flow by older investors. Here again, the numbers tell the story: Canadian Balanced Funds – Fixed Income Focus, up 39.3 per cent in assets year-over-year; Canadian Income Balanced up 18.9 per cent; Canadian Dividend and Equity Income Funds, up 17.9 per cent.

People want foreign funds and they want cash flow. Presto – global income funds sprout like crocuses in the spring.

Of course, that leads to some problems. For starters, it’s hard to find these funds. There is no Global Income category so they are sprinkled among existing categories, sometimes with no apparent rhyme or reason. Second, most of these funds have no track record. They promise great things – high monthly payments plus capital gains potential. How well they’ll deliver is another matter.

Many of the big fund companies are already on board. You’ll find one or more global income funds in the line-ups of AIC, Acuity, BMO, CIBC, CI, GGOF, IA Clarington, Mackenzie, and Templeton. You can bet there are more on the way.

One of the few funds with any kind of track record is the Clarington Global Income Fund, which has been around since the beginning of 2001. It has not been a strong performer in terms of total return, mainly because it was hit by the one-two punch of the bear market and the rise of the Canadian dollar in its early years. As a result, it barely broke even over the five years to Feb. 28. Recent returns have been better but caution is still advised. The fund pays monthly distributions of 6c a unit, or 72c a year. That works out to an astounding projected cash flow return of 14.9 per cent over the next 12 months based on a recent NAV of $4.84. Of course, there is no way the balanced portfolio, which is two-thirds in stocks and one-third in bonds and cash, can produce that kind of income. The only way the payments have been sustained to date is by steadily eroding the fund’s NAV. That’s can’t go on forever and I expect the distributions will have to be reduced sooner rather than later.

We’ve seen a similar phenomenon with the Mulvihill Premium Global Income Fund, which pays out 10c a unit quarterly. The projected cash yield over the next year at that rate is 9.75 per cent. That’s not as high as that of the Clarington fund but it too is probably unsustainable. The Mulvihill fund was launched in April 2000 with an NAV of $10 per unit. The recent NAV was $4.10, which means this fund has lost 59 per cent of its original value over the years. Investors have been paying an annual management fee just to have their own money returned to them.

So if the idea of a global income fund intrigues you, I suggest being very careful. Be sceptical about the promises being made, especially if the fund seems to have an unusually high distribution. What you want is a fund that has a better than even chance of generating above-average returns which in turn will enable the managers to maintain the payments without eating away at the capital base.

Adapted from an article that originally appeared in Mutual Funds Update, a monthly newsletter that provides advice on fund selection and strategies. For subscription information: