The recent bounce is encouraging, but the bear market isn't over yet: Chief market strategist
It’s another sad twist on the “buy low, sell high” investment creed: stock markets fall into a correction (or worse) and nervous investors hit the sell button.
Canadian investors pulled nearly $5 billion from mutual funds last month, according to the latest tally from the Investment Funds Institute of Canada (IFIC). It’s the first time in a year and a half that IFIC reported net mutual fund redemptions, as concerns over inflation and rising interest rates devalued major equity markets. The S&P 500, for example, is down nearly 15 per cent so far this year.
It’s a stark reversal from a pandemic buying spree that started as markets surged starting in late March 2020, after a similar correction that also saw net mutual fund redemptions. As markets gained momentum in 2021, IFIC reported a $111.5-billion jump in mutual fund sales; nearly four times the $29 billion in 2020, which was in line with average annual sales going back to 2000.
It’s tough enough to make money in mutual funds without falling into the emotional trap of buying high and selling low. Most Canadians invest in mutual funds for their retirement savings because they are the only investment products that offer professional management and diversification for average-sized portfolios.
Annual fees often top two per cent of the total amount invested — even when a mutual fund loses money. That means the mutual fund holder loses 12 per cent when the investments in the mutual fund lose ten per cent in a year; making the loss even worse.
Part of that fee goes toward paying the management team that selects the investments that go into the fund and the advisor who sells the fund to the investor. Not all mutual funds are purchased through an advisor, but the role of professional management should be risk management to limit losses, and a basic explanation of how investing works and why it’s a bad idea to sell when markets are down.
When you strip out fees, mutual fund performance tends to run in tandem with the benchmark indices they track. In other words, a Canadian equity mutual fund will post similar gains or losses to the S&P/TSX Composite Index. Technology mutual funds, as another example, often track the S&P 500 Technology Index.
The close correlation between mutual funds and the indices they track generally means the mutual funds will recover when the broader markets recover. It’s hard to determine how close the correlation is, or what risk management measure are put in place, because mutual funds are not required to disclose much about the fund.
Most funds will list a few top holdings; but the companies that provide them are only required to update the disclosures periodically. Considering most mutual funds lag their benchmarks by about the same amount as the average fee, it can be assumed many fund managers merely replicate their holdings.
The largest net mutual fund redemptions in April, according to IFIC, were in balanced funds ($2.05 billion). Balanced funds tend to be most popular among novice investors because they mimic a balanced portfolio of stocks and bonds.
Rock bottom interest rates and resulting rock bottom bond yields have been a drag on the performance of balanced funds — but that could be turning around as interest rates rise and fixed income produces better payouts.
By that same logic, better days should also be ahead for bond funds, which oddly enough had net redemptions of $1.75 billion in April. Many bond funds have declined in value in the nearly three decades of low interest rates as portfolio managers attempted to trade their way into better returns on the bond market.
And so, it’s likely that investors who dumped their bond funds in April were selling low.