Do the opposite
Investors should go foreign
An old episode of the popular sitcom Seinfeld featured one of its main
characters, George Costanza, undertaking a dramatic behavioural change. George
figured that his basic instincts were so bad, that he would simply do the
opposite of every one of his urges. It worked amazingly well. There is a
valuable lesson here for mutual fund investors.
For calendar 1999, pure stock funds accounted for 82 percent of net sales.
Almost half of that – 37 percent of total mutual fund net sales – went to U.S.
and other foreign stock funds. But sales momentum into foreign stock funds
accelerated as the year progressed – and spilled into 2000. During the year
2000, stock funds accounted for 102 percent of total mutual fund net sales, of
which nearly 60 percent went to foreign stock funds.
The subsequent performance is now part of the greatest bubble in history but
it’s interesting to note that foreign stock funds – the very funds for which
investors showed insatiable hunger – far outperformed the then-shunned Canadian
Over the past five years (ending September 30), Canadian stocks have returned
an average of 6 percent per year. U.S. and overseas stocks, by contrast, have
lost an average of about 4 percent per year over the same period. That’s an
outperformance by Canadian stocks of roughly 10 percentage points annually for
the past five years.
However, five years ago, U.S. and foreign funds were looking much better if
compared – at that time – based on past returns. Therein lies the problem – and
The striking trend in mutual fund sales today is not only investors’
collective preference for yield or income oriented funds but the apparent
hesitation to step back into foreign markets. That’s not to say that no foreign
funds are attracting money. Big, strong past performers in the global equity
class from AIM-Trimark, Brandes, and Mackenzie, for example, have been raking in
money hand over fist.
I am not, however, suggesting that people pile into technology funds now. But
today’s trend has a common denominator with most past trends in investor
behaviour; namely that investors follow past performance. Such behaviour
invariably leads investors astray of the ‘buy low, sell high’ mantra. This has
translated to long-term mutual fund investor performance that has not
compensated for the risk taken.
A glance at sales figures over the trailing one and two years doesn’t reveal
any dramatic difference in sales of stock funds. However, when you consider that
income trusts are just another form of Canadian equities, it’s clear that
investors are showing a strong preference – still – for Canadian equities over
their foreign counterparts. Performance and perceived stability play a big part
in this preference.
Foreign stock funds saw more than $384 million walk out the door. In both
absolute and relative terms, this is the highest figure in two years – since the
awful third quarter of 2002. Canadian stock funds – when excluding dividend and
income trust funds – also remain in net redemptions but not at the increasing
pace of foreign funds.
There are two rationales that come to mind that explain this behaviour.
Investors are simply replacing significant portions of their stock exposure with
income trust funds. The perceived safety of monthly distributions and the
demographics case for an increasing demand for yield combine for a good supply
and demand picture going forward. Plus, overseas stocks – having lost 4 percent
annually for the last five years – just don’t look nice.
Again, the underlying issue here is largely one of past performance. And
history strongly suggests that investing on this basis is a losing proposition.
I estimate that the current exposure to foreign stocks – considering only
IFIC reporting mutual fund assets – is near the median for the last eleven
years. But it’s at its lowest point since March 2003 and (before that) June
1998. Not coincidentally, mutual fund investors’ peak allocation to foreign
stocks of more than 48 percent was reached in August 2000.
Those dates should ring a loud bell since they are near past troughs and
peaks in performance. I’m not suggesting that we’re at the beginning of a bull
market for overseas stocks. But overseas markets are cheaper and offer some
diversification benefits. Plus, with our dollar flirting with the US$0.80 range,
currency risk has been substantially reduced. Granted, I said this when the
loonie was in the low-to-mid 70s (U.S. cents per Canadian dollar) but this is
even truer today.
Advisors and investors may be weary of buying investments from a class with
already negative performance, but that’s really the better time to build
Dan Hallett, CFA, CFP is the President of
Dan Hallett & Associates Inc. in Windsor Ontario. DH&A is registered as
Investment Counsel in Ontario and provides independent investment research to
financial advisors. He can be reached at