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number cruncher

What are we looking for?

Income-bearing mutual funds that have paid out more than today’s five-year mortgage rates.

The screen

According to a recent Globe article, Canadians renewing a mortgage today will be subject to five-year fixed rates in the neighborhood of 6 per cent. Homeowners who entered into mortgage agreements five years ago will be faced with an uncomfortable bump in payments, which in most cases will see the interest portion double. The age-old question of whether to invest or pay down debt might today tilt much further toward addressing debt for those who are risk-averse. But for those who can handle the risk and believe they might be able to outperform the five-year fixed rate by investing, today’s screener might provide some ideas.

To start with, I used Morningstar Direct to look for Canadian-domiciled mutual funds that have outperformed their category peers in the past, as denoted by a Morningstar rating of four or five stars. Then I looked at funds that Morningstar believes have the ability to outperform category peers on an after-fee basis, denoted by a Morningstar medalist rating of gold, silver or bronze. (That rating is derived by our qualitative analysis of the people running the fund, the investment process, and the stewardship qualities of the parent firm). From here, I screened and ranked on a few factors:

  1. How the fund performed in every trailing 12-month period over the past five years. I summarized this by taking each 12-month trailing return over the past 60 months and averaging them. To qualify, this figure had to be 10 per cent or greater. This seemingly arbitrary filter was included because of the fact that investments are subject to taxes in Canada and it is assumed that investors cannot shelter the entirety of a presumed mortgage down payment within a traditional tax shelter like an RRSP or TFSA. Today’s highest marginal tax rate on unsheltered income is between 45 per cent and 55 per cent. Here, I assume conservatively that if an investment fund gains 10 per cent in a given 12-month period, half is paid in taxes. In reality this tax rate is lower for lower-income individuals, and lower on dividends paid from qualified Canadian companies.
  2. Consistency. To avoid investments that are too risky, I also screened for funds with a Morningstar Risk Rating of “low” or “below average”. This risk rating methodology accounts for the fact that investors care more about volatility/risk on the downside, and less on the upside.
  3. How the fund structures its distributions. Though investors can create their own cash distributions by redeeming units of a mutual fund on a disciplined schedule, investors who must make monthly mortgage payments might prefer a consistent deposit into their investment account. Hence, I looked at the last five years of distributions, assuming a $100,000 investment, and screened for those that have historically paid more than 10 per cent a year, averaged over five years. Although this distribution can be provided by dividends or bond payments from holdings in the portfolio, it can also be accomplished by a mechanism called return on capital, where money is returned to the investor out of the original capital invested, lowering the cost basis for units of the fund and deferring taxes until the position is sold.

I then ranked the qualifying funds on how consistent their distributions have been (not shown in the table.) Only fee-based mutual funds and ETFs (those available to fee-based accounts where the cost of advice is charged separately by the advisory firm) were considered in today’s search.

What we found

Funds paying out more than mortgage rates

NameMorningstar CategoryMorningstar Rating for FundsMorningstar Medalist RatingMorningstar Risk Rating 5Y Average of 12M rolling Return (%)5Y Average Distributions as a % of 100,000 investment (%)Total Ret YTD (%)Total Ret 1 Yr (%)Total Ret Annlzd 3 Yr (%)Total Ret Annlzd 5 Yr (%)Total Ret Annlzd 10 Yr (%)MER (%)Inception Date
Fidelity Dividend Series F8Canadian Dividend & Income Equity5 StarsSilverLow11.311.5%3.11.911.
Fidelity True North Sr F8Canadian Equity5 StarsSilverLow11.111.8%
Manulife Cdn Equity Priv Pool CT6Canadian Equity5 StarsSilverBelow Avg12.710.1%9.57.613.712.110.11.002012-12-12
CI Synergy Canadian Corporate Class EFT8Canadian Focused Equity3 StarsBronzeBelow Avg10.112.3%
Mackenzie Bluewater Canadian Gr F8Canadian Focused Equity3 StarsBronzeBelow Avg10.511.2%
Manulife Fundamental Dividend FCanadian Dividend & Income Equity5 StarsBronzeBelow Avg10.111.6%
Fidelity Canadian Opportunities Sr F8Canadian Equity5 StarsSilverBelow Avg17.514.3%13.814.813.416.311.61.072013-04-17
Fidelity Concntr Val Priv Pool Sr F8Canadian Focused Equity5 StarsSilverLow14.512.2%
Manulife Canadian Dividend Growth FT8Canadian Dividend & Income Equity5 StarsBronzeBelow Avg10.210.3%4.12.510.59.21.042016-01-29
Fidelity Canadian Large Cap Sr F8Canadian Focused Equity5 StarsSilverLow14.414.4%6.19.917.613.39.71.062013-04-17
Manulife Fundamental Equity FCanadian Focused Equity5 StarsBronzeBelow Avg12.910.8%12.612.112.012.810.71.082004-02-11

Source: Morningstar Direct | Data as of November 14, 2023

The funds that qualified in the screen are listed in the accompanying table, alongside their management expense ratios (MERs), historical performance, and ratings. It is important to note that multiple-share classes of similar funds qualified, but for conciseness I’ve shown the share class with the lowest MER. Of course, the caveat to this analysis is that equity markets are generally quite risky, and the investment environment is arguably fundamentally different than it was five years ago given the rise in inflation and subsequently interest rates. Finally, investors are urged to have a look first at the category to which each fund belongs, giving an indication of what geographic and asset-class exposures are in each fund.

This article does not constitute financial advice, it is always recommended to conduct one’s own independent research before buying or selling any of the funds or ETFs mentioned in this article.

Ian Tam, CFA, is director of investment research for Morningstar Canada.

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