Managed Money Reporter Newsletter — Issue 194, April 2003

Editors: Carl Spiess & Allan McGlade

Featured Articles

Market Commentary: A Month Later 

Four weeks ago the War in Iraq was the primary focus of investors, and markets took wild swings with each new report from CNN.  How much can change in a month.

The focus for financial commentators speculating on the short term direction of the market, is now back to corporate earnings.  Long term investors recognize that cash earnings are what ultimately drive the value of a stock investment.  However, investors can be excused for being skeptical about the markets, based on the performance of stocks over the last three years.

In this month's newsletter, Allan McGlade reviews a popular investment vehicle which many investors are finding to be a terrific way to remain exposed to the market's potential, but without having to worry that your principal is at risk a decade down the road.

We have also added the Spring Edition of ScotiaMcLeod's Investment Portfolio Quarterly to our site.  The current issue covers topics like income trusts, split shares as well as Canadian and US economic outlooks.

Segregated Funds Revisited

If the continued volatility of the stock markets around the world has you worrying about the long term security of your equity investments and you are finding the interest rates available on GICs and bonds unappealing, segregated funds might be the right investment for you!

Segregated (seg) fund values have experienced similar performance of their mutual fund cousins during this nasty bear market. For investors of equity based segregated funds this means they have seen negative returns for the past couple of years. The difference between investors in segregated funds and normal mutual funds however is that the seg fund investor is guaranteed to get their capital back should the markets experience an even longer downturn. This special feature of segregated funds may be the right prescription for you if you have been experiencing anxiety about about maintaining exposure to the current equity markets.

As well as other features, segregated funds guarantee that investors will get back at least 75%, and in many cases 100% of their original investment after ten years. This might sound like a long time but investing in the equity markets is supposed to be a long term commitment. The guarantee feature of segregated funds protects investors if the equity markets should ever experience an extreme prolonged downturn while allowing them to participate in the more likely scenario of rising markets. Most segregated fund families also offer a death benefit guarantee of 100% or more of the original investment should the annuitant die during the ten year period. This is often seen as a valuable feature for older investors. 

Many of the segregated fund providers such as ManuLife Financial and Maritime Life also provide the ability to guarantee the value of investment gains when the market rises through a guarantee reset feature. Each company offers their own unique process for doing this however and it is worth exploring which structure best suits your needs.

Segregated funds offer other features such as creditor protection, which can be a big benefit for business owners and professionals such as doctors, lawyers, accountants and engineers. Segregated funds can also avoid probate fees, and currently seg funds are not subject to the foreign content limits within RRSP accounts.

There are as many investment categories within segregated funds as with mutual funds. So if you are a balanced investor you will not have a problem investing in a balanced fund or building your own portfolio of bond, Canadian equity, global equity and specialty funds. If indexing is your preferred approach there are index seg funds for any of the major North American markets. I think it is safe to say that Nasdaq index investors who chose a seg fund version over a mutual fund version three years ago are thankful they decided to accept the higher management fee in exchange for the capital guarantee. Most segregated funds, but not all, carry an management expense ratio (MER), that is higher than similar mutual funds. Segregated funds such as ManuLife's GIF product which offer brand name mutual funds with all the segregated fund features carry MERs that are approximately .25% to 1% higher than the underlying mutual fund.

We believe that the equity markets will outperform the current yields on GICs and bonds over the next ten years.  If, however, you have some concerns and want to protect your original investment, just in case, segregated funds might be the right investment vehicle for you.  Here are some useful links:

To find out more about segregated funds please call or email Allan. He has an extensive background in insurance products and he will be more than happy to help you better understand the features of segregated funds and to determine if they make sense for you.

Fun With Numbers

Assuming the worst: According to Chicago's Ibbotson Associates, the S&P 500's worst 10-calendar-year stretch was the period ended December 1938. During those 10 years, the S&P 500 lost money at a rate of 0.9% a year. In the current decade, the S&P 500 has already had three consecutive losing years. How much worse could it get? 

Suppose the decade that started in 2000 turns out to be just as dismal as the 10 years through 1938. What does that mean for the next seven years? The news is pretty heartening. If the current decade is going to match the 10 years through 1938, Ibbotson calculates that stocks would have to climb 5.7% annually over the next seven years.

Clocking 5.7% a year might seem like small potatoes after the dazzling gains of the 1990's. Still, it is a lot better than the 3.82% yield currently offered by 10-year US Treasury notes. 

Source: Wall Street Journal, 02-26-03 

Income Trusts - Good News / Bad News

The recent Ontario budget speech proposes protection for income trust investors, who might have been exposed to unlimited liability.  Unfortunately, one income trust (Halterm) saw its market value drop by 75% in one week recently, after a major contract on which its cash flow was based was lost and not immediately replaced.

ScotiaMcLeod currently has a recommended list of Income Trusts, but is currently cautious about adding more at current valuations.  More information can be found in the Spring Investment Portfolio Quarterly.  Of course, many of our available income trust mutual funds offer a more diversified way to invest in income trusts.

Looking at Exchange Traded Funds for Fee Savings?

Many clients are rightfully concerned about the management fees on their mutual fund investments.  The logic is almost inescapable, higher fees mean lower returns.  But there is always more to the story.

Two new kinds of funds became popular in the late 1990s: Index Funds and Exchange Traded Funds (ETFs).  Several years ago, we added information to our site about Index Funds and ETFs, noting their low-fee benefits, and also their risks.

Now that the iUnits S&P/TSX 60 ETF has been around for 3 years, it has become the largest fund in the Canadian Large Cap category with $4 billion in assets.  It is also the only fund with over 1/2 billion of investor's money that is currently ranked as below average (2 out of 5 stars).  In the 3 years ending March 31, 2003, it has lost and average of 12.6% a year, vs. the median Canadian Large Cap fund loss of 8.3%.  Investors have been lured by the sirens song of low costs, but have missed out on the lower risk and thus more stable returns of actively managed funds in the recent tough market.  (Both of these figures are reported after fees, proving that good management can be worth paying for.)  

It is important to note that part of the iUnits S&P/TX 60 ETF long term underperformance stems from the large holding of Nortel in 2000.  Many active fund managers were prohibited from owning a high proportion of a single stock, and the ETF's returns are better than average in the short term.  And, in a strong up market, ETFs and index funds will again outperform the majority of the actively managed and more expensive traditional funds.  However, we find that clients are more concerned about minimizing the risk of losses.  Please ask us if you have questions on the relative returns, costs and benefits of your current fund investments.

Fund News - E&P Equity Rotates Away - AGF Fund Mergers - AIM Fund Consolidations 

Elliott and Page have announced that the $171-million E&P Equity fund, which has been capped since Dec. 31, 1998, is designated for a merger.  On March 18, Manulife Mutual Funds — a division of Elliott & Page Ltd., which sponsors the Elliott & Page family — announced that it was seeking approval to merge Elliott & Page Equity into Elliott & Page Blue Chip

AGF India, along with AGF Latin America, is to be merged into AGF Emerging Markets Value.

AIM is consolidating many of its sector Theme, RSP and Class funds into larger funds like the AIM Global Theme Fund.

We are in favour of these fund consolidations, as they ensure that investors are shifted into funds that are being proactively and suitably monitored by the fund management firms.

Mutual Fund Reporter Recommended Website of the Month 

If you have had the same email address for a while, you are now getting regular offers to renew your mortgage, increase your anything, and many other too good to be true specials.

While there is the occasional interesting email that arrives completely unsolicited, many can be hazardous to your financial health.  The central African diplomat emailing you from a country you have barely heard of who wants to entrust you with $20 Million of "family fortune" is looking for your banking information.  Do some research first!  Here are some interesting links:


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