A walk through the world of mutual funds

Over and over again, the industry preaches the merits of diversification. It is the one principle of investing that has stood the test of time. Over 500 years ago, Jacob Fugger the Rich said it like this, “Divide your fortune into four equal parts: stocks, real estate, bonds, and gold coins. Be prepared to lose one of the most of the time. During inflation, you will lose on bonds and win on gold and real estate: during deflation, you lose on real estate and win on bonds, while your stocks will see you through both periods, though in a mixed fashion. Whenever performance differences cause a major imbalance, rebalance your fortunes back to the four equal parts.”

Today, when we look at investing we have far more choices than Jacob had 500 years ago. The mutual fund world alone has 5000 choices broken down into 35 different categories. Over the next couple of weeks, I will walk through some of the categories to help you make better decisions with your mutual fund portfolio.

Fixed income funds

There are seven different types of fixed-income investments:

  1. Canadian Bonds,
  2. Canadian Money Market,
  3. Canadian Mortgage,
  4. Canadian Short Term,
  5. Foreign Bond,
  6. High Yield Bond, and
  7. US Money Market.

Currently, there are 703 funds in these 7 categories with 223 in the money market categories.

Many investors appear to be concerned about the threat of rising interest rates and the impact that will have on bond prices. There is an increasing popularity in bonds with a shorter term, high yield bonds, and real return bonds because these bonds will be less sensitive to rising interest rates.

Canadian equities

While the term Canadian Equities may sound straight forward, there are also many variations of the Canadian Equity fund. According to the Canadian Investment Funds Standards committee, there are 4 different kinds of Canadian Equity categories. Currently, they differentiate between Canadian Equity funds that maximize the 30% foreign content and the funds that have little to no foreign content. With the proposed elimination of foreign content, this is likely to change. Also in this category are Canadian Dividend Funds and Canadian Small Cap funds. These categories are all popular because the Canadian Equity market at all levels has performed very well relative to the global environment.

Dividend funds appear to be especially popular because investors like the notion of getting regular cash flow. There is a general shift away from growth investments to income paying investments. Dividend funds could be a great way to play the Canadian Equity market.

Income trusts

Income Trusts have led the popularity wave over the last five years. In fact, the popularity is so significant that some experts feel that another bubble has emerged ready to burst as the tech bubble did in the year 2000.

The Income Trust category has really emerged as an asset class of its own. Some compare income trusts to equities while others feel the fixed yield makes it a perfect fixed income alternative. The debate continues but the fact remains that income trusts will have much greater downside risk and volatility compared to fixed income funds. Logically, when you buy an income trust, you are still buying into some type of business venture and investors should really consider the risk similar to equity risk.

Balanced funds

This category is a massive one with over 1000 funds to choose from. In this category, you can choose between 732 Canadian Balanced funds or 338 Global Balanced Funds.

The key in this category is to not judge the book by the cover. You will find many different variations of balanced funds within this single category. For example, you will find the traditional type of balanced fund with about 60% equities and 40% fixed income like the Trimark Income and Growth. The equities will tend to be larger cap Canadian equities and the bonds will tend to be government bonds. On the other hand, there is a newer style of balanced funds, which will diversify into some more popular asset classes like income trusts, corporate bonds, and high yield bonds. One example of this type of balanced fund is the CI Signature Income & Growth Fund. The composition of this fund is much more diversified. Both of these funds have solid track records but just do it in different ways. Interestingly both funds are quite highly correlated.

Global equity funds

This is probably the biggest category of funds with over 1600 funds to choose from. Global investing is very important. Studies have shown that global diversification is so important to Canadian investors because Canada is such a small market. There are many different variations of global funds:

Regional Global Funds – Within the global fund category, you can buy specific regional markets like the US, Europe, Latin America, Emerging Markets, Pacific Rim, Japan, and Asia. You may favor a region of the world and look to invest in that area through one of these regional plays.

Broad Mandate Global Funds – the Broad Global Fund category, you can buy funds that are basically invested everywhere and anywhere around the world. The benefit of choosing a global fund is you let the manager decide where in the world to invest. One of the most famous Global Funds is the Templeton Growth Fund. Currently, the biggest exposure lies in Europe, which can give you a sense of where the manager George Morgan is able to find some value.

International Equity Funds – International Equity Funds are very similar to Broad Mandate Global funds except that they will not hold US content. They will invest anywhere in the world except for the US and usually not in Canada as well.

The interesting thing about this category is the lack of popularity. Investors today all flock to Balanced Funds, Canadian Funds, Income Trusts and Fixed Income. This can be seen in the most recent reports from the Investment Funds Institute of Canada (IFIC) where foreign equities were being redeemed to the tune of $900 million dollars in the first quarter of 2005. Compare that to Fixed Income Funds, which took in $2.5 Billion of sales, the balanced funds that took in $3.6 billion and the dividend and income category that took in an amazing $4.2 billion.

We’ve seen this euphoria before and while it is impossible to time the next major shift, it may be the time to start thinking against the grain and look to the global equity category for future gains. Remember everything goes in cycles.

Sector funds

Similar to the Global Regional Funds that allow you to invest in a specific part of the world, the Sector Fund category allows investors to hone in on a specific sector that they favor. There are six key sectors that you can invest in Resource, Precious Metal, Science and Technology, Health Care, Financial Services, and Real Estate.

Alternative strategies

The Alternative Strategies category is the fastest-growing category in the mutual fund industry. There are currently 123 funds to choose from, but almost 60% of these funds have less than a 3-year track record. In fact, only 15% or 18 funds have a 5-year track record. Although Alternative Strategies have been around for a long time, they have really become popular through mutual funds in the past 5 years.

The Alternative Strategies category, also known as the hedge fund world can be a great investment if used properly. Investors need to be extra careful about what they buy and they need to understand the risks associated with hedge funds.

My two cents

So there we have it – a walk through the world of mutual funds. Hopefully, you have a better understanding of the different categories and some of the issues each category faces today. Investors will never be able to predict the future with any degree of consistent accuracy. Knowing which category to invest in is probably the hardest decision to make. Rather, what is important is to build a portfolio that incorporates many categories to diversify your risk.

Remember Jacob Fugger the Rich and the lessons that came from his words over 500 years ago. Diversify your assets and be prepared that at least one of them will lose from time to time. Instead of chasing performance by selling your losers and buying your winners, fight the urge and do the opposite. Take the time to rebalance your portfolio from time to time, as it will force you to sell high and buy low which is really the only way to make money in investing.


  1. Juan

    There certainly are a lot of options when it comes to investing. Also, having a healthy degree of international exposure can help to provide some diversification for a portfolio.

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