People are frightened. We don’t need sophisticated consumer confidence indexes to tell us that. All we have to do is watch the wild gyrations of the stock markets on any given day and look at the latest statistics from the mutual funds industry.
The September numbers reported by member companies of the Investment Funds Institute of Canada (IFIC) were grim. Investors cashed in their units to the tune of $4.5 billion in net redemptions – that amounts to a tsunami of sell orders.
Somewhat surprisingly, more than half the redemptions – about $2.5 billion – were in money market funds. This may seem counter-intuitive because money funds are supposed to be safe havens in troubled times but perhaps investors are worried that some of the funds may be holding toxic short-term notes. As I pointed out a couple of weeks ago, some companies have already acknowledged minor exposure to Washington Mutual, AIG, and Merrill Lynch debt. The concern is that other funds may be at greater risk than anyone has yet admitted. IFIC comments that “a lack of delineation by investors between troubled Money Market funds domiciled in the United States and Canadian Money Market funds has likely contributed to the size of the outflows this month”.
There’s another reason why investors are fleeing money funds. The major banks are aggressively seeking new deposits by offering GICs at rates much higher than we would normally see in the current circumstances. Royal Bank has been heavily promoting four-year GICs at 4.5 per cent and two-year deposits at 4.25 per cent. Scotiabank has a 30-month GIC that pays 4.5 per cent. With returns on money market funds likely to fall over the next year if the Bank of Canada continues to cut its key rate as expected, those bank deals look pretty sweet to nervous investors.
Less surprisingly, people were also selling equity funds in September with net redemptions of $992 million. That brings the total amount pulled out of stock funds in the first three quarters of this year to $8.7 billion – a massive vote of non-confidence if there ever was one.
Of course, if Warren Buffett is right this is the time to buy equity funds, not to sell them. But he’s taking the long view, even though he is 78 years old.”Most major companies will be setting new profit records five, 10 and 20 years from now”, he says. Perhaps he believes he’ll still be around then. Most people in that age group have a much shorter time horizon.
If you’re a mutual fund investor who doesn’t want to take a lot of risk but doesn’t want to be out of the stock market entirely, what should you own now? Here are two suggestions.
Mackenzie Sentinel Income Fund (B units). This is a balanced fund that is weighted towards bonds and cash. However, it does have slightly more than one-third of its assets in blue-chip stocks so it is not immune to losses in a steep decline such as we have experienced. But the nature of the portfolio has kept the damage to a minimum; the fund was down 4.4 per cent for the year to Sept. 30. Most people would have been delighted to get off so easily. (Incidentally, that was the worst 12-month period in the fund’s history, which is a good indication of its stability.) Over the long term (10 years) the B units, which I recommend, show an average annual gain of 6.3 per cent. They pay a monthly distribution of 3.33c each.
RBC Monthly Income Fund. This is another balanced fund that is weighted towards bonds and cash although the equity exposure here is higher at 46.3 per cent. Like the Sentinel entry, it lost ground in the past year with a decline of 3.5 per cent but that’s almost like a profit in the context of what has been happening. Over five years, the fund shows an average annual gain of 8.3 per cent which should be enough to satisfy all but the greediest investors. The fund pays out 4.75c a unit each month (57c a year). That translates into a projected cash yield of 4.9 per cent although keep in mind that if the portfolio does not generate at least that high a return, the distributions will erode the net asset value. One important point: RBC only offers this fund for non-registered accounts. You can’t buy it for an RRSP or RRIF.
Ask a financial advisor if either of these funds is right for you.
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, click here.
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