What are we looking for?
Funds with low correlations to Canadian equities.
The screen
Although trading sessions on Monday and Tuesday added some much needed relief for Canadian equity investors, the most recent drawdown on the stock market is a reminder that sticking close to a reasonable risk budget will help alleviate some of the heartaches associated with deep market corrections. Put another way, maintaining a well-diversified portfolio of multiple asset classes with low correlations to one another will lead to a more stable path to financial freedom.
With this in mind, today I use Morningstar Direct to look for Canadian-domiciled funds that have historically had low (or negative) correlations to the S&P/TSX Composite Index. To find these funds, I measured correlations between the S&P/TSX Composite Total Return Index and Canadian-domiciled mutual funds over three distinct periods: January, 2008, to February, 2020; January, 2015, to February, 2020; and September, 2018, to February, 2020. (Remember that a correlation of one would mean that two investments move in lockstep over a specified period. A correlation of minus one means that two investments would move in opposite directions historically.)
I then screened the fund database on two dimensions:
- The Morningstar rating over all, known to most as the “star” rating – a backward-looking assessment of a fund’s net-of-fee risk-adjusted return against similar funds. Ratings range from one to five stars, where funds receiving five stars have outperformed their peers historically, after fees. The star rating is a great starting point in understand which funds have historically performed the best within a category.
- The Morningstar Quantitative Rating, or “medalist” rating – a forward-looking assessment of a fund’s prospective ability to outperform similar funds after fees, based on five factors: people (the quality of management team); process (the effectiveness and consistency of the investment process); parent (organizational structure and talent retention); performance; and price (fees). Ratings include gold, silver, bronze, neutral and negative.
To qualify, funds must have a medalist ratings of four or five stars, a medalist rating of bronze, silver, or gold, and must have a correlation less than 0.8 across all three aforementioned time frames.
More about Morningstar
Morningstar Research Inc. is a leading provider of independent investment research in North America, Europe, Australia, and Asia. Morningstar offers an extensive line of products and services for individual investors, financial advisors, asset managers, retirement plan providers and sponsors, and institutional investors. Morningstar Direct is the firm’s multi-asset analysis platform built for asset management and financial services professionals. Morningstar Canada on Twitter: @MorningstarCDN.
What we found
The funds that meet the requirements are listed in the table inclusive of their category (asset class), ratings, management expense ratios, correlations and trailing returns.
Note that the D class shares from RBC and PH&N here are made available through discount brokerages and do not come with embedded fees for advice, and hence their MERs are comparatively low. The F-class funds listed are delivered through advisers who manage fee-based accounts. Typically, fee-based advisers will charge an overall management fee for advice separate from the MERs listed here. The remaining funds have the full embedded commission listed as part of MER, which includes the cost of advice.
Although there is a clear cost, the value of good advice and financial coaching should not be overlooked, especially during tough times like we are seeing today.
This column does not constitute financial advice. It is always recommended to speak to a financial adviser or investment professional before investing.
Ian Tam, CFA, is a relationship manager for CPMS at Morningstar Research Inc.
Be smart with your money. Get the latest investing insights delivered right to your inbox three times a week, with the Globe Investor newsletter. Sign up today.
Ian Tam, CFA