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Investment Ideas The dirty little secret of value funds, rising small-cap stars, and the most-shorted stocks on the TSX

There is a mystery afoot in the stock market, one that should concern anyone who invests in actively managed mutual funds.

The mystery boils down to this: Most of these funds appear to be deliberately ignoring much of the research about how to beat the stock market. Presumably the managers know all about this research. They just choose to go in a different direction.

This odd situation is the focus of a recent working paper from Martin Lettau and Paulo Manoel of the University of California, Berkeley, and Sydney Ludvigson of New York University. Their paper asks, “Where are the value funds?” and points out that there are virtually no funds on the U.S. market that actually hold only cheap stocks, even among the funds that label themselves as value investors.

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The same contrariness holds true with other factors that academics have found to be important in determining investment returns. For instance, researchers have demonstrated that investors can benefit from momentum strategies that buy stocks that have shot up in recent months. But most funds don’t appear to take advantage of this anomaly either.

The researchers conclude that their survey of actively managed U.S. mutual funds reveals “that these funds do not systematically tilt their portfolios towards profitable factors.” And, no, the researchers don’t understand why.

Read the rest of the article (for subscribers) via this link.

-- Ian McGugan

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Stocks to ponder

MTY Foods Group Inc. (MTY-T). MTY operates restaurant franchises, including Thai Express, Country Style and Extreme Pita, and has a market capitalization near the $1.5-billion mark. MTY stock has provided shareholders with a strong 28-per-cent average annual total return over the previous 36 months. The company’s stock has been oversold four times in the past three years according to RSI and a significant price rallied followed on each occasion. There are only two index members trading at attractive, oversold Relative Strength Index levels below the buy signal of 30 – Uni-Select Inc. and MTY Foods Group Inc. Scott Barlow takes a look at the stock (for subscribers).

The Rundown

Small-cap stars on the rise: The little-known TSX Venture stocks with eye-popping returns

In the small-cap space, you can tap into the kind of growth that gets the pulse racing. But it’s also part of the equity ecosystem that’s home to future incumbents of mainstream investing. On Thursday, the TSX Venture Exchange released its annual Venture 50, showing the fastest-growing stocks in the Canadian small-cap ranks. The group of listings, featuring cannabis companies, emerging tech names and junior resource stocks, generated an average return of 94 per cent last year – a mark that no company in the S&P/TSX Composite Index managed to match. The average stock in the Canadian large-cap index declined by 13 per cent in what was a difficult year for stocks globally. Tim Shufelt reports (for subscribers).

TFSA or RRSP: Which one is a better choice for you?

The registered retirement savings plan (RRSP) is one of the best-known tax shelters available to Canadians, particularly in the weeks before the annual contribution deadline, which is March 1 this year. But financial experts say a tax free savings account (TFSA) is often a better choice over the long run. The problem is, many people don’t know what make a TFSA different from an RRSP. A report by Bank of Montreal estimates that 32 per cent of Canadians are in that camp. David Paddon from The Canadian Press explains.

Buffett’s Suncor bet to revive investor interest in Canadian energy

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Berkshire Hathaway Inc.’s reinvestment in Suncor Energy Inc. highlights the benefits of being an integrated oil company and could revive investor interest in the languishing Canadian energy sector, fund managers said. The move is also seen by some as a wager the energy sector could benefit from a change in the guard in oil-rich Alberta, which has an election this year. Berkshire’s new 0.7-per-cent stake in Suncor, valued at $488-million at current prices, is already worth 23 per cent more since Berkshire bought it in the previous quarter. It comes more than two years after it sold, for $618-million, a 1.4-per-cent stake it had bought in 2013 and added to in 2015. Reuters reports.

Short sales on the TSX: What bearish investors are betting against

Despite the sharp rally in TSX stocks since Christmas, short sellers’ bets as of mid-February remain elevated. This should be a concern for market participants, given academic research has found that heavily shorted equities tend to underperform over time. Larry MacDonald takes a look at the stocks investors sold short the most.

Others (for subscribers)

Merrill Lynch sees ‘green shoots and greed’ ahead

Pinterest confidentially files for IPO: report

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Dividend investors: There’s a freight boom coming down the track

Wall Street, seeking big tax breaks and big returns, sets sights on distressed Main Streets

Friday’s Insider Report: Vice-chair sells nearly $6-million in this rising security yielding over 5%

Friday’s analyst upgrades and downgrades

Others (for everyone)

Advisor insights: Five ways to attract clients

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TSX Composite earnings scorecard: How fourth-quarter results have fared

Caterpillar, Apple among big names hit by U.S.-China trade war

Ask Globe Investor

Question: I’m a 60-year-old retiree and would like to invest my RRSP with low-fees and a yearly return of 5 to 7 per cent – what would you recommend?

Answer: Even the most reasonable investment return expectations have to be reality-checked these days.

Sounds like an easy one, right? Wouldn’t a good low-fee balanced mutual fund or exchange-traded fund work, or a diversified portfolio of stocks and bonds?

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Possibly, but I have concerns.

For one thing, this reader didn’t offer any information about risk tolerance or other retirement savings. That 5-per-cent to 7-per-cent average annual return would require a portfolio with a significant weighting in stocks, probably well more than 50 per cent. The level of investor consternation about the 8.9-per-cent decline by the S&P/TSX Composite Index last year suggests a lot of people may not be comfortable with a portfolio heavily tilted to stocks.

When you add a substantial bond weighting to a portfolio, you reduce price swings and risk on both the downside and upside. The Canadian bond market’s three-year average total return (price changes plus bond interest) was 1.9 per cent for the period ending Dec. 31. The Canadian stock market made 6.4 per cent, while the U.S. market made 8.6 per cent in Canadian dollars.

Investing in low-cost exchange-traded funds would mean fees of roughly 0.25 per cent or less – that’s for individual ETFs or balanced ETFs, which give you all the elements of a diversified portfolio. Add the cost of buying and selling ETFs through an online broker and you still have a modest overall cost of investing. But is this reader cut out to handle a portfolio of ETFs? My sense is that some people are not, much as they’d like to give ETFs a try.

A robo-adviser can make good sense for the aspiring ETF investor who needs help, but there’s an added cost of as much as 0.5 of a percentage point on top of ETF costs. This will further weigh on those targeted 5 per cent to 7 per cent gains.

The bottom line here is that 5 per cent on an average annual basis might be a more realistic target for a 60-year-old RRSP investor than 6 per cent or 7 per cent. Overshoot on your return expectations and all kinds of things can go wrong – you get too aggressive, you sell at a market low and then you’re too afraid to buy back in.

--Rob Carrick

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Compiled by Gillian Livingston

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If you would like to write a letter to the editor, please forward it to letters@globeandmail.com. Readers can also interact with The Globe on Facebook and Twitter .

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