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  What's behind the July mutual fund boom?

BENJ GALLANDER and BEN STADELMANN

Friday, August 19, 2005

The Globe and Mail's Report on Business recently reported that sales of mutual funds for July are expected to be close to $1.65 billion — 200 percent more than for the same period in 2004, and the best July since the dot-com bomb year of 2001.

This was the third consecutive month of strong gains, and cumulative sales for the first seven months of 2005 nearly equal the full-year tally for 2004.

Heck, the last time we saw a giant rebound like this in Canada, it was off Tretiak's pads and onto the stick of Paul Henderson. For contrarians, these kinds of numbers automatically set off the red light above the goal.

One analyst explained that the move was market-driven, caused by the rise in the S&P/TSX composite index, and that this instils confidence. Yet this rise in value is concentrated in a single sector: energy. Once again, the herd would seem to be late to the table and engaging in a stampede fuelled by an emotional melange of greed and the comfort of safety in numbers.

Behaviour like this can be a sign that the bull is getting tired. Certainly, the momentum can continue for a while, but as the ranks of potential new recruits become depleted, it is unlikely that these funds will be able to provide the big returns that mutual-fund investors are clearly anticipating.

Exactly how investors were buying these funds is unclear. Are they aware that the average cost of purchasing a mutual fund has not come down in Canada, as is the case in the U.S.? Research keeps confirming that costs profoundly affect returns. Could it be that investors have become more savvy and informed about selecting funds, or perhaps that investment advisers are ferreting out hidden gems for their clients?

One piece of evidence provided doesn't support that assumption: five hugely capitalized mutual fund companies accounted for more than 75 percent of July's gains.

That's just too concentrated to show that investors were making better decisions. The more plausible explanation is that investors were simply pulling their favourite brands off the shelves, as if cruising down the aisle for groceries.

It does not necessarily imply cheaper buys and access to better management for buyers. Some of the best returns can come from small fund companies operating out of unpretentious digs and managing smaller assets, which allow them to be more agile in less liquid markets.

With less emphasis on marketing, their cost structure also tends to be lower. Good advisers should be helping investors to seek them out. If not, interests might be misaligned.

The worst scenario taken from these happy-face fund numbers could illustrate that investors have given up on — or still ignore — alternatives like individual stocks, ETFs, and even some cheap hedge funds with low minimums.

Jim Cramer wrote in his book Confessions of a Street Addict that the mutual fund model is flawed. He notes that the smaller investor should pay only a small nominal fee when a mutual fund doesn't provide a specific positive return, as is usually the case with hedge funds.

Mark J. Heinzl concluded in his book Stop Buying Mutual Funds that investors can always do better on their own. Yet, because of time constraints or anxiety, the simplicity of letting a fund manager do the work will always attract a pool of small investors.

July's figures show that this pool might be too large, too uninformed, and ready to be disappointed again just as they were four years ago.

Well, at least home-shredders can look forward to a steady meal of fund statements.


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