Managed Money Reporter Newsletter — Issue 209, September 2004

Editors: Carl Spiess & Allan McGlade

Featured Articles

Fund News - Investors Group, AIC, AGF, CI Investigated for Past Market Timing Practices

Prompted by the fund industry probes in the US, several Canadian fund companies are being investigated by the Ontario Securities Commission .  The issue involves the controversial practice of allowing market timing.  "Market timers" refers to large fund holders who traded in and out of foreign funds, based on their expected movement the next day due to previous changes in foreign markets.

Unlike the illegal Late Trading scandal in the States, in Canada it was and still is impossible to buy "after the close"  due to a central mutual fund clearing system.  However, the practice of market timing, which is not illegal but which we strongly believe is unethical, was harder to monitor with the billions flowing into and out of funds each week.

Each of the affected fund companies have stated that they had already put procedures in place in 2003 to catch clients who were making such large, short-term trades, but may face financial penalties for having knowingly or unknowingly allowed the practice in the past. Speaking personally, we hope the actual clients and advisors who may have participated in these practices will also see reprimands and are forced to repay any ill gotten gains.

What does this all mean? 

We have come up with two analogies that will help investors understand how this may have affected them:

Many department stores and other retailers have product return policies that are generous. That is generally good customer service. But if clients abuse that policy, who is to blame? Some retail clients at stores return their purchases after using them once. Every store has clients that scam them, wear a dress once, then return it, or buy a tent before the long weekend, then return it. The retailer then winds up passing the costs of that lax return policy onto all of their good long term clients. But it is not the retailer that benefits or should be charged with having a lax policy, it is the clients who are doing the scamming, who are doing something ethically wrong even if it is not illegal.

Another closer analogy in the financial industry: If a handful of clients scam an insurance company with bogus insurance claims, it costs all the other policyholders a bit more. But is the insurance company at fault for the client's fraudulent claims?  We think only if they allow it to continue to happen after it is discovered.

To our minds, the mutual fund companies are guilty of lax policies, but do not deserve the one sided press reports that completely miss the point that it was not the fund companies who were doing the market timing, it was some of their clients. It is worth noting, that the only long term clients that would have been impacted by the market timers were in international funds, and if even measurable, the effect would likely only have affected prices by fractions of cents a share. We're not being apologists for the companies being investigated - they should have had policies that would have stopped a handful of their clients from abusing the system.  At least they all do now.

It is very important to note that these investigations do not affect the unit prices for clients who are in funds today, and the news in no way compromises the security of your current fund investments.  However, depending on the outcome of the investigations, we hope that clients who were in affected international funds could someday see some nominal positive adjustments to their accounts, should the OSC find that there was any quantifiable harm to the many long term fund investors caused by the actions of a few short term traders.

Time To Look at Your Big Picture

One trend that Allan and I have been noticing of late is that clients are increasingly consolidating their various accounts with ScotiaMcLeod, and their banking with Scotiabank.  For clients using online banking, this provides the benefit of seeing all of their investments on one screen.  (Scotia's Online Banking and Brokerage site was again voted the best in Canada by Gomez.)  Especially for clients approaching retirement, having one simplified point of contact for their investments saves time and money, and ensures that you get the best advice for your entire portfolio.

Remember, most fund company RRSP accounts can be consolidated into a ScotiaMcLeod account without having to actually change the funds.  We simply request an "in-kind" transfer, and your Royal, CIBC, TD, PH&N, Altamira, Mackenzie, Sprott or other funds appear consolidated on your ScotiaMcLeod statement.

Please use the handy RRSP transfer form to consolidate your other RRSPs into your ScotiaMcLeod RRSP or contact us if you have any questions.

Resource Funds - A Way to Beat Price Increases at The Gas Pump?

Hedging Your Bets

This week, oil prices soared above $48 a barrel after data was released showing a decline in America's fuel stocks in the aftermath of Hurricane Ivan.  With all the talk about rising energy prices, many investors wonder what can protect them from possible further increases in gasoline, oil and natural gas prices.  Others wonder if rising energy prices will return us to 1970s era inflation.  What kinds of investments can offer protection?  

In real dollar terms, (adjusted for inflation) oil is significantly cheaper than it was after the 1973 oil crisis.  In fact, oil is still half the price in real dollars that it was in 1980.  And over the last decade, natural resources have not been a stellar asset class.  The worst 10 year performer has only returned 1% a year over the last decade. 

However, over a shorter 2 year period, one of the best performing asset classes has been resource funds, largely due to the recent run up in oil and gas prices.  Resource funds can include mining and other resource extraction industries, but since there is a separate precious metals fund category, most funds in the resources sector are primarily invested in oil and gas exploration companies. For a client who invested $2,000 in a resource fund last year, the average 20% return for that category to August 31st 2004 translates to a $400 gain.  That would certainly offset the increased costs a typical consumer would see at the gas pumps and on their home heating bills.  

Are you thinking "I wish I had invested in the resource sector"?  Well, not to worry.  You probably did without even realising it. Buying a resource fund or resource stock isn't the only way to get into the oil & gas market. Since the energy sector makes up almost 20% percent of the TSX, most Canadian investors already have good exposure to these companies through index or broadly diversified equity mutual funds. So if you own a Canadian equity mutual fund or two, you made money on those high prices at the pump.  Now won't that make you feel better next time you fill up?

We do have concerns that the energy sector is now fully priced, and only significant global tensions will push oil prices higher.  We're all hoping global tensions will continue to decline and if that is the case, there will be softness in this sector in the near term.  While your returns may not be as strong in this sector shortly, it'll mean the world is a happier place and you'll even save some money at the pumps.

Investing in Resources

Longer term, there is no doubt that gas reserves in North America are on the decline, and only significant investments in LNG (liquid natural gas) shipping from overseas will meet the significant demand that continues to build. For this reason,  many investors will want to see a portion of their assets invested in the natural resources sector - in spite of short term prospects.  As mentioned above, you likely already have some exposure to resources through other investments but if you feel you might need to up your emphasis in this field, we can help. While we don't generally recommend investing in individual resource companies (it's just too risky), there are several well-managed resource funds out there. Contact us for help - we'll want to recommend something that fits your particular situation.

In addition to investing directly in energy funds, there are a number of tax related flow through limited partnerships that become available each year.  For someone with an annual income of $100,000, a $10,000 investment in a flow through partnership will yield nearly a 100% write-off and result in over $4,500 in tax savings.  After a two year holding period, the proceeds of the investment are then taxed as capital gains when sold, for what has historically provided excellent after tax returns.  We expect only a limited selection of flow throughs this year, and the year end ones are generally not as attractively priced as the partnerships offered early in the year.  If you are interested in this type of investment vehicle, please contact us so we can provide more details on this for you.

Video Library

For Carl's recent CP24 interviews, including one on resource funds, please visit our new video archive at:

Short Term Rates Rise Again

In both Canada and the US, short term interest rates are on the rise.  The Bank of Canada overnight target was raised by 1/4% to 2 1/4% on September 8th. Similarly, the US benchmark Fed rate was raised by 1/4% to 1.75% on September 21st.  These are still low rates by historical standards.

However, for longer term bond investors, we haven't really seen any increase in rates.  In fact, after the last rise in short term rates, long rates fell, (in the US to under 4%) as investors became more confident that the value of their long term bonds will not be eroded by future inflation.  This confounded investors who were staying short to try and buy bonds when long rates go back up.  The chart to the right shows that long term rates in the states are actually right at their historical average and well below their lows of the 1950's.

We expect to see a flattening of the yield curve, meaning that short and long term rates will become more similar, but historically long term rates are almost always higher than short rates.  A strategy of laddering bond maturities continues to work well in this environment.

For a great live update on where interest rates are, and a live graphical update of the Canadian yield curve, please visit our bonds quotes page.

Reminder - Our New Address Scotia Plaza 15th Floor

We are now moved into our new offices on the 15th floor of Scotia Plaza, and look forward to meeting with you there soon.

Mutual Fund Reporter Recommended Website of the Month

If you are interested in tax advantaged Limited Partnerships, Creststreet is one of the most respected names in Canada.  In addition to their oil and gas partnerships, they have also been the first to offer investors the ability to invest in wind powered generation projects, also with significant tax advantages.


Contact Us

T.  416.863.RRSP (7777)
F.  416.863.7479

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