Managed Money Reporter Newsletter — Issue 155, January 2000

Editors: Carl Spiess & Allan McGlade

Featured Articles

Index Heavyweights

Pity the plight of Canadian mutual fund managers. The stock markets in Canada have been rough enough for the last three years and now they face a new investing challenge. What to do about Nortel Networks?

Most investors understand that mutual fund managers operate in a very competitive environment. There are literally thousands of mutual funds in Canada and their managers must post strong performance numbers to attract and retain investors. Their performance is always measured by how their fund compares to that of a peer group of similar funds and also how they did in relation to some benchmark "index". For equity fund managers, the index in question is usually the Toronto Stock Exchange or TSE 300.

Happy New Year! The index technically covers the 300 largest publicly traded companies on the TSE and it is supposed to represent how Canada and Canadian investors are generally doing. In order to better achieve this result, the index is weighted - or biased - towards the larger companies with the bigger market capitalizations. In other words, a company's weighting is determined by the number of shares it has outstanding times the price of its shares. If either of those numbers go up at a time when the rest of the companies in the index stay relatively constant, then a company's weighting in, and importance to, the index will rise.

In general, the structure makes sense. There are far more investors who are concerned about the performance of the very large companies than how the very small companies are doing. Similarly, there is a whole lot more money at stake when an index heavyweight increases or decreases dramatically than a junior issue. A somewhat distressing example of this statistical bias is the tremendous impact Bre-X had on the broad market both on the way up and on the way down. In matters of the stock market, size does matter.

Hence the Nortel dilemma - the incredible run-up in the price of Nortel shares over the past year (see graph, below) now means that the technology giant accounts for a whopping 15.6 percent of the Toronto Stock Exchange 300 index. The company has been on a tremendous roll over the past year as it forges into new business areas and aggressively grows its sales and profits. Investors, particularly American investors, like what they see and they have rewarded the company with a high price to earnings multiple. The shares now trade at roughly 50 times forecast earnings which is extremely expensive in the old world of investing yet it is still seen as something of a bargain in context of the times. The technology giants like Microsoft or Cisco or Intel all trade at relatively the same lofty levels but they are American.

Nortel is one of ours and it is essentially in a class by itself. The company is 40 percent owned by telecommunications giant BCE which accounts for another 10.5 percent of the TSE 300 index. Taken together the two companies have a combined market weight that is greater than most of the sub-indices. For example, the oil and gas portion of the index amounts to just 10.58 percent of the TSE 300.

Nortel's Big Rise

Mutual fund managers who strive to beat the index - and they all do - have to put in place a "Nortel" strategy. If they ignore or underweight the stock, then a manager's risk of relative underperformance soars if the company's heavyweight status carries on. The managers might choose to bet against Nortel on the basis that the shares are either too expensive or because a large weighting would overly expose their portfolio to the performance of a single company in a volatile business. Unfortunately, in a competitive business where results count for so much, the reasons may not matter.

Most of the large funds in Canada did underweight Nortel and quite a number didn't even include the giant in their top ten holdings. Many of these large funds will have some explaining to do. If it makes the managers feel any better, they can take comfort in knowing that the challenges posed by a heavyweight in a small investing pond, do exist elsewhere. Nokia of Finland accounts for 56 percent of the local index while HSBC Holdings represents 27 percent of the Hong Kong Exchange.

Fund News

New Dynamic RSP Funds

  • Dynamic RSP Americas
  • Dynamic RSP Europe
  • Dynamic RSP Far East
  • Dynamic RSP International
  • Dynamic RSP Power American

New BPI Funds

  • BPI American Opportunities
  • BPI Global Opportunities III

New AIC Funds

  • AIC American Focused
  • AIC RSP American Focused

New SVC O'Donnell Funds

  • O'Donnell U.S. Mid-Cap RSP
  • O'Donnell World Equity RSP
  • Strategic Value Europe RSP
  • Strategic Value World Balanced RSP

SVC O'Donnell Fund Changes

The following funds are capped:

  • Strategic Value Asia Pacific Fund to be replaced by Strategic Value Asia and Emerging markets Fund.
  • O'Donnell Short-Term Fund and O'Donnell Canadian Bond Fund to be replaced by O'Donnell Money Market Fund.
  • O'Donnell Select Fund to be replaced by O'Donnell Canadian Large Cap Fund

Renewing Your Mortgage?

We Can Help!

Scotiabank offers:

  • Special rates to ScotiaMcLeod clients and families
  • 2.25% cash back option
  • 2.5% cash back when paid directly to your RRSP account
  • 15% prepayment feature
  • Four month rate guarantee on mortgage transfers

Please email us or call us (1-800-387-9273) if you are about to renew your mortgage and find out how Scotiabank can help.


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