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(RICHARD DREW)
(RICHARD DREW)

Portfolio Strategy

Kings of Pain loaded with investment lessons Add to ...

Never buy an investment product without first checking how it performed in 2008.

The financial crisis was the ultimate stress test for mutual funds and exchange-traded funds. The crisis didn’t last one precise calendar year, but 2008 was where the most damage was done. The S&P/TSX composite index fell 33 per cent, the S&P 500 fell 23.8 per cent and the MSCI World Index fell 29.4 per cent (both latter indexes measured in Canadian dollars).

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The up and down stock markets we’ve seen lately are a far cry from 2008, but they do remind us that it’s important to have an idea of how our investments might perform in a falling market. In this edition of the Portfolio Strategy column, we look at mutual funds and exchange-traded funds that fell hardest in 2008. Call them the Kings of Pain.

Here are six things we can learn from the Kings:

1. It’s not all fun and games with commodities

High-flying commodity prices are the main story behind the success of the Canadian stock market in recent years. But reversals in commodity prices can be crushing.

The average natural resource equity mutual fund was on a multi-year roll of delivering fat double-digit returns heading into mid-2008. By the end of that year, these funds averaged 12-month losses of 45.5 per cent and, as you can see on the accompanying chart, several lost more than half their value.

It’s the same story with Canadian equity and Canadian focused equity funds with big weightings in commodity stocks. Losses of between 40 and 50 per cent were not uncommon.

Rising commodity prices are a function of strong economic growth, which is by no means assured when you look at what’s happening in the United States, Europe and even China, where the government is trying to rein in growth to control inflation. Don’t give up on commodities, but do monitor your exposure to ensure it’s not excessive.

2. Be careful how you get your gold

The price of gold has been hitting new highs lately, a reminder of how investors regard it as a haven in uncertain times. But the experience of 2008 shows that investors have to be discriminating in how they buy exposure to gold or they won’t get the safe haven benefits.

Gold bullion prices did rise a little bit in 2008, and yet investors holding precious metal mutual funds lost 40 per cent on average that year. One explanation is that precious metal funds typically hold a large percentage of their assets in gold mining stocks, which fell hard in 2008.

Gold stocks are certainly a way to benefit from a rising gold price, but don’t expect to get the same crisis protection as actual gold. For that, you want a gold bullion fund or ETF.

3. Small stocks, big risks

Canadian small- and mid-cap funds ranked right up there with natural resource funds in terms of shocking setbacks in 2008. The average loss for the category was about 40 per cent, but harsher losses were not uncommon.

The entire stock market was a disaster area in 2008 – even the big blue chips that make up the S&P/TSX 60 index fell about 33 per cent. But the less well established companies in small-cap funds were a fair bit worse.

Note that resource stocks are a popular holding with some small cap funds, which means you’re getting a double dose of risk.

4. Beware of currency hedging

Currency hedging means whatever happens in currencies should not affect your portfolio – for better and for worse. This is great at times when our dollar is rising and therefore reducing the value of investments from other countries, but bad when the loonie is on a sharp downtrend.

That’s what happened in 2008 – the U.S. dollar was the safe currency and investors bailed on others, including the Canadian buck. If you owned non-hedged mutual funds or ETFs, you had currency working in your favour in 2008 (okay, at least it helped lessen your losses a bit).

We’ve already seen that the S&P 500 fell 23.8 per cent in 2008 in Canadian dollars; in U.S. currency the decline was 38.5 per cent. What happened if you tracked the S&P 500 using an ETF with currency hedging? The answer can be found in the 40.3-per-cent loss posted by the iShares S&P 500 Index Fund, listed on the Toronto Stock Exchange under the symbol XSP.

5. The math of losing and regaining money is cruel but not beyond hope

Mackenzie Universal Canadian Resource Fund lost a rather sharp 56.2 per cent in 2008, but didn’t it more than bounce back the next year with a gain of 67.4 per cent? Not really. In fact, big losses can only be offset by much bigger gains.

If you own an investment that falls 50 per cent in value, you need it to double the next year to get back to where you started (this did happen to a few funds in 2009). If you have patience and a good fund manager, you can also make back your losses over time. According to Globeinvestor.com, a $10,000 investment in Mackenzie Universal Canadian Resource in January, 2008, would now be worth about $11,042.

6. No bond or balanced funds on the list

One of the best performing categories in 2008 was global bond funds, which benefited from both a rush out of stocks and into bonds, and from the decline of the Canadian dollar. Canadian bond funds averaged a gain of 2.8 per cent.

Balanced funds, which contain varying mixes of stocks and bonds, could not avoid losing money. But the bonds they held had the effect of capping their losses. The average Canadian-balanced fund with a tilt toward stocks over bonds lost 21.3 per cent in 2008, which isn’t even close to King of Pain levels.



______________

Widely available mutual funds and exchange-traded funds that lost 40 per cent or more of their value in 2008, the worst year of the global financial crisis.

Fund

Category

2008 loss (%)

2009 gain (%)

5-yr Rtn (%)*

MER (%)

Assets ($-mil)

TD Canadian Equity

Cdn Focused Eq

-42.2

47.2

4.6

2.13

3,512

Mackenzie Univ Canadian Resource

Ntrl Resources

-56.2

67.4

5.9

2.47

1,803

Dynamic Power Canadian Growth

Cdn Focused Eq

-51.4

54.9

2.9

2.32

1,756

Sprott Canadian Equity

Ntrl Resources

-43.7

36.0

7.0

2.81

1,690

Mackenzie Cundill Recovery 'C'

Global Small Cap

-53.8

60.3

4.9

2.52

1,627

iShares S&P 500 Index Fund (C$ Hedged)

U.S. Equity

-40.3

22.9

-1.2

0.24

1,565

Investors Summa SRI Fund

Cdn Focused Eq

-49.6

55.6

-0.2

2.69

1,049

Investors Canadian Natural Resource A

Ntrl Resources

-49.6

138.3

8.9

2.70

1,044

iShares MSCI EAFE Index (C$ Hedged)

Intrnl Equity

-40.6

18.1

-3.3

0.50

1,044

RBC O'Shaughnessy U.S. Value

U.S. Equity

-44.0

24.8

-1.5

1.50

905

Dynamic Global Value

Global Equity

-43.8

47.3

0.6

2.39

901

Dynamic Focus+ Resource

Ntrl Resources

-50.7

113.0

15.8

4.19

886

Investors Euro Mid-Cap-A

European Equity

-41.2

27.4

-0.3

2.71

810

Manulife Growth Opportunities

Cdn Small Cap

-40.5

57.6

4.6

2.65

790

Sentry REIT

Real Estate Eq

-42.7

36.6

2.7

2.65

787

Investors Canadian Small Cap A

Cdn Small Cap

-43.2

62.8

6.8

2.70

721

Sprott Gold And Precious Metals

Precious Metals

-49.6

113.8

8.9

2.84

701

AGF Canadian Growth Equity Class

Cdn Small Cap

-48.2

49.3

1.3

2.90

677

Dynamic Power Global Growth Class

Global Equity

-47.2

30.0

9.7

2.45

643

Mackenzie Univ Precious Metals

Precious Metals

-46.1

66.8

9.0

2.47

570

Dynamic Power American Growth

U.S. Equity

-44.1

13.4

7.4

2.35

492

RBC Global Energy

Ntrl Resources

-50.0

40.9

-0.4

2.09

489

Manulife Advantage

Cdn Focused Eq

-51.1

45.0

-0.2

2.46

487

Sceptre Equity Growth-A

Cdn Small Cap

-54.0

61.6

4.7

1.58

420

RBC Global Resources

Ntrl Resources

-49.6

48.8

12.2

2.21

392

BMOSpecial Equity

Cdn Small Cap

-47.6

54.7

7.3

2.41

355

AGF Canadian Resources Class

Ntrl Resources

-50.2

59.2

3.2

2.98

351

DMP Resource Class

Ntrl Resources

-57.2

84.8

3.7

2.63

351

Investors Global Natural Resource A

Ntrl Resources

-44.4

67.9

7.0

2.84

343

Mackenzie Univ Emerging Markets Class

Emerg Markets

-40.4

44.8

6.8

2.53

308

Dynamic Power Small Cap

Cdn Small Cap

-40.1

41.5

5.4

2.64

303

Mackenzie Growth

Cdn Focused Eq

-59.9

63.4

-2.7

2.43

301

* Rtn to June 30. Source: Globeinvestor.com





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Editor's note: An earlier online version of this article incorrectly referred to a $1,000 investment in the 19th paragraph. That has now been corrected to $10,000.

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