The Danger of Theme Funds

Country Routes May 1997

As I have written about a couple of times before, the number of mutual funds continues to grow. There are currently 1,419 mutual funds available, up a little from the 200 when I started in the business in 1983. This number is expanding and I would guess could reach 2,000 by the year 2000. In the U.S. there are approximately 6,000 which are more than the stocks available.

One of the reasons this number is so large is the public's acceptance of mutual funds as a vehicle to invest their money in. Another reason is the proliferation of niche funds or theme funds. You can invest now exclusively in high tech, new economy, new product, gold, telecommunications, health care, natural resource, infrastructure, etc. There are also single country funds such as India and Korea. Along with these are funds such as South American, Asian and European.

One of the initial reasons or advantages that people liked or enjoyed when buying mutual funds was diversification. The purchase of a single mutual fund allowed a person to have a reasonable amount of safety by spreading the risks, not having all your eggs in one basket. The broader the mandate, the less volatile or risky.

As I mentioned before, the granddaddy of mutual funds in Canada is the Templeton Growth Fund started in 1954. It has a broad global mandate investing in many countries, across economic sectors in areas such as banking, telecommunications, utilities, metals and mining, insurance, financial services, transportation, etc. along with a portion in bonds and T-bills (cash). It would be called a global fund. Once you start to narrow the mandate by limiting the areas of investment, you begin to increase risk. One trend I have noticed in the last few years that disturbs me a little are people being lured into investing into these theme funds after hearing about their potential and the large returns they can make. This wanting to make a lot of money quickly investing in mutual funds is a disturbing trend. Although not a mutual fund but a stock, the latest Bre-X fiasco illustrates the point.

You will make a lot of money investing in the right mutual funds over the long-term. When a person buys a mutual fund he/she also hires professionals to make the buying and selling decision for them. Now with these more volatile theme and sector funds, people are treating them more like stocks by trading them on a more frequent basis. This usually occurs in the no-load, no-advice area by direct marketers of mutual funds such as Altamira. They had to limit trades on their funds to, I believe, 12 a year because of people treating them like stocks. I often ask these people who want higher returns over shorter periods of time, "Why don't you buy and sell stocks? You can make the proverbial "killing" owning individual stocks instead of mutual funds." One of the reasons they don't is the fact that they realize the increased risk involved and the fact that they really don't know enough to accept the traditional risks involved. They like to do it with mutual funds because it gives them a sort of buffer between them and the stock market.

Now, I'm not against owning theme funds. In fact, I own telecommunications and health care along with single country funds such as India and Korea. Korea illustrates the point I want to make in this article. Unfortunately, I have several of my clients involved with Korea. Some are down more than 30%. Have they lost money. NO, not yet, because they have not sold yet, so this represents a paper loss. One of the other reasons they still hold it is because they are still making money on their overall portfolio. You see, Korea represents a small percentage of their portfolio. Their portfolios have what I like to call foundational funds such as Templeton to broaden or lessen the risks. Each client has a different risk tolerance. For some people, even leaving the guarantees of GICs is more risk than they can live with.

I have written two articles about risk before. I try to carefully construct portfolios for each client based on the risk tolerance I believe they can live with. There are people who invest in the best mutual funds who still lose money. How? They sell at a loss when they see the value of their fund going down (temporarily). The present reality of seeing a paper loss is more than they can endure and they bail out, often to never return. Unfortunately, I had a couple of clients who did that. I thought they understood the five year minimum time frame. Apparently not. Can you imagine selling the Templeton Growth Fund because it showed a paper loss of less than 5%. Usually after they sell, it is back into positive territory shortly after.

If you have any questions, please call Reg Borrow at (519) 855-6639. He is an Independent Financial Consultant with Regal Capital Planners Ltd.

Money Matters Index                                 Home Page

Created: Mon Sep 23 10:30:50 1996
Web Page designed and created by Champ Consulting Services, Georgetown, Ontario