Seeing the Good in Bad Mutual Funds

Comeback stories and funds under new management can be an opportunity for investors to buy low, writes Rob Carrick, reporter and columnist for The Globe and Mail.

When bad things happen to good mutual funds, smart investors pay attention.

Stock markets as irrepressibly strong as we've seen lately make it tough to find opportunities to invest in anything that hasn't soared in price.

One strategy is to look for mutual funds with excellent long-term results that have stumbled lately. In today's high-flying markets, they represent a rare opportunity to buy low.

Another approach is to look for long-time laggards that have turned things around in the past few years. These funds include comeback stories—once-respected funds that hit long-term slumps—or funds under new and better management.

Both of these strategies were fed into the fund filters on the GlobeinvestorGold Web site, and the results are presented here.

Some quick notes before we get to the funds:

• All mutual fund categories were considered, but US-dollar versions of funds, pooled funds, and segregated funds were excluded.
• Funds have been evaluated according to their quartile performance, which reflects returns relative to peers over selected periods; a first-quartile ranking means a fund is among the elite in its category and a fourth-quartile means the opposite.
• Funds were automatically knocked off the list if they had a management-expense ratio (MER) of more than 2.5%, an arbitrary limit designed to screen out egregiously expensive funds.
• Minimum investments of $10,000 or less were required.
• Manager continuity is key—to make the list of buy-low candidates, a fund must have been managed by the same people for at least the past five years.

The Screen
These funds all have first-quartile results for the ten years to March 31, and fourth-quartile results in the past 12 months. In other words, they're long-term stars that have fallen back among the laggards in their respective categories.

Remember, all of these funds continue to be managed by people who were responsible for all or much of the strong ten-year returns. Ten-year returns are vastly more important than one-year results, but there is nothing to say a fund's current slump couldn't be prolonged. So don't buy and expect an instant turnaround.

Comments: Three funds from the Dynamic family top our list, which is ranked alphabetically. Dynamic has had a run as one of the hottest fund companies around, thanks to strong returns throughout its lineup.

Here, we find a reminder that no fund stays hot forever. Investors looking to broaden the global exposure in their portfolios might investigate Dynamic Global Value, which has been managed by Chuk Wong since 1999, and is one of only a dozen or so global-equity funds that hasn't lost money for investors over the past ten-year period.

One proviso is that this fund is more volatile than most in its category and plunged almost 44% in 2008, compared with 31% for the average global equity fund.

Dynamic Power Canadian Growth is a similar story—a wild ride that cumulatively has generated excellent returns over the past decade.

NEXT: More Funds…

Comments: High-yield bond funds are popular these days, not only because they've been making good money, but also because they're a useful way to diversify the bond side of a portfolio to help it stand up better to rising interest rates.

This fund is pricey, as is the trend at Investors Group, but it has managed to combine good long-term results with a significantly lower level of volatility than its peers. The loss of 7.6% in 2008 compared with 9.7% for the category average.

Comments: This fund offers a simple proposition: Give up some returns when markets are soaring in exchange for armor-like protection in down markets. Following the usual script, this fund has been dismal in recent days.

Long term, it's a member in good standing of the exclusive club of global-equity funds with positive ten-year returns.

Comments: Once a big player in income trusts, this fund is now a more conventional, balanced product holding a mix of blue-chip dividend stocks and bonds. Returns have dipped below average lately, but they've been well above 5%.

Note: Morningstar Canada says much of the distributed amount has been classified as a return of capital in recent years.

Comments: The current managers of TD Small Cap Equity took over in 2005, and that's roughly when the fund began to regularly outperform its peers on average. TD Diversified Monthly Income is a similar story—a change of managers several years ago helped perk up performance.

Comments: Trimark was once a fixture on the list of the bluest of blue-chip mutual-fund companies. Then came a buyout by the big US firm now known as Invesco, followed by the departure of key managers and a dilution of the old reputation for savvy, patient long-term investing.

The recent revival of Trimark Select Balanced and Trimark Canadian is notable, because both funds have managers who are Trimark stalwarts with tenures dating back to the 1990s.

Trimark Canadian is a good example of a fund that gives investors a different look than the S&P/TSX composite index. The fund has about 55% of its assets in energy, materials, and financials, while the index is almost 80% weighted to those sectors.