Ferreting out the good funds among the bad

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Not all actively managed mutual funds are necessarily bad

You have probably heard the accusations before: Actively managed mutual funds are to be avoided because the majority under-perform benchmark indexes due to hefty sales fees and annual management expense ratios (MERs).

But is it fair to generalize that all active mutual funds should be avoided because they tend to underperform on an average basis? Might there be some pockets of good among the bad and ugly?

Take fund companies that sell their funds directly to the investor, without huge advertising budgets or the intermediaries of financial planners. They have no sales loads and charge lower MERs, so they are in a better position to at least match the market's return.

Some examples of low-MER, active equity funds (and their MERS) are: Beutel Goodman Canadian Equity Fund (1.2 per cent); Mawer Canadian Equity Fund Series A (1.25 per cent); and Leith Wheeler Canadian Equity Fund Series B (1.5 per cent). All three, by the way, have performed better than the 10-year average annual return of the S&P/TSX composite index.

Mutual-fund families sold through direct channels may have higher MERs than index funds and exchange-traded funds (ETFs), but they come with extra services that some investors may find outweigh the cost factor.

Margot Bai, author of Spend Smarter, Save Bigger , would agree with this view. In particular, she values the front-line staff who can assist (at no charge) with asset allocation, rebalancing and other portfolio management tasks across the various funds offered by the company. As she says: "Best of all … you gain access to free investing advice from their own in-house investment advisers! When setting up your investments, an adviser will help you assess your risk tolerance and recommend funds appropriate to your goals ... You get the best of both worlds: low fees and unbiased, professional investment advice!"

As with most mutual-fund firms, there are other conveniences, such as: dollar-cost averaging through pre-authorized deposit accounts, dividend reinvestment programs, and rebalancing of funds - all commission-free. Then there are administrative services such as tracking adjusted cost bases (ACB) on investments.

Opening an account with a low-fee, mutual-fund family can be as simple as visiting the company's website to obtain application forms and/or a contact person. Its funds can also be purchased through discount brokers (who might also sell Class F mutual funds, which are funds normally sold through financial planners but have had their trailer fees stripped out).

Table 1 shows several of the low-fee mutual fund families available in Canada. A distinguishing feature is minimum investment requirements. While some minimums are on the high side, they can be spread over several funds within the family.

Table 1: Low-fee mutual-fund families

Many low-fee fund companies are the retail arm of pension-fund managers. Buying into their funds puts your money into the hands of the pros who manage portfolios for corporate pension funds, endowments, non-profit organizations, and high net-worth persons.

Choosing a fund group involves examining several variables. The number of funds in the family is important to check because it affects how diversified a portfolio you can build. The level of client support is another.

Each fund group will have its strengths and weaknesses. For example, Phillips, Hager & North is said to have some of the best dividend and bond funds around, but its U.S. and global funds do not enjoy similar reputations. For this reason, you might want to spread your money (if possible) over more than one fund family.

You may have not heard of many of the low-fee mutual funds. "That's a good sign," says Ms. Bai. "Brand recognition is a bad thing in the world of mutual fund companies because it means they are spending significant amounts of money on advertising." Low-fee funds don't need to advertise a lot because their performance often speaks for itself, she adds.