'Timing is key': Supercycle effects still loom over long-term fund returns

Looking at the latest 15-year fund performance figures, you'd think that Canadian equities are absolutely the best investments in the world, especially the small and mid caps. Resource and precious metal funds, despite ongoing commodity headwinds, don't look too shabby either.

Those were among the top-performing categories in the Canadian mutual fund universe for the 15-year period ended Dec. 31, 2016, according to data provided by Fundata Canada Inc. Real estate equities (a small category comprising just three funds with 15-year track records) and energy equity funds rounded out the Top 5, even though oil prices now hover around the US$50 per barrel mark. Canadian dividend/income equity funds held sixth place in terms of 15-year performance.

The implications of Table 2 (below), which lists the Top 15 out of 28 total funds that achieved double-digit 15-year returns through 2016, are even more dramatic: The vast majority of these funds were Canadian equities and most were also in the small/mid-cap space. By comparison, not a single foreign fund of any kind achieved double-digits (most came nowhere close, although those resource and precious metals funds do hold varying degrees of foreign content).

So, is Canada really that hot of an investment mecca that our funds are the strongest in the world If the U.S. markets have indeed been booming lately, why have Canadian returns from U.S. equity funds averaged a paltry 2.8 per cent annually over the past 15 years And what about small/mid-caps — how do these funds manage to consistently outperform in such a crowded and risk-prone sector Is it currency Better companies Or just plain luck

None of the above, according to fund executives contacted by the Financial Post.

“It's all about resources,” says Drummond Brodeur, senior vice-president and global strategist with Signature Asset Management (a division of CI Investments) in Toronto. “The Canadian economy is indistinguishable from resource markets.

“It's been a great party, but the timing is key — it was exactly 15 years ago that China reintegrated with the global economy by joining the World Trade Organization (WTO), and launched the biggest commodities boom the world has ever seen,” Brodeur says. “It was a fantastic opportunity for Canada, given our resource-heavy economy and the fact that we've completely gutted our value-added industries such as manufacturing.”

“In 2001, the Canadian dollar was at  62 cents US and oil was around US$20 a barrel,” Brodeur adds. “The commodity boom drove the dollar up to a peak of $1.10, and oil reached US$147 in 2008. But the boom was over by 2011 and Canada has sucked wind ever since, notwithstanding the dead cat bounce last year. So the 15-year picture is distorted by the effect of China's unprecedented infrastructure program.”

Terry Dimock, head portfolio manager at National Bank Investments in Montreal, agrees that Canada's outperformance during the past 15 years stemmed primarily from the Chinese commodity juggernaut, which was sufficient to more than offset the subsequently dwindling performance of Canadian markets during the last five or so years. As evidence he points to the graphic contrast between Canadian and U.S. indices during the two periods.

“If you look at the S&P/TSX Composite Index, it had an annual compound return (including dividends) of 8.9 per cent between 2001 and 2010 while the S&P500 had an annual compound return of 3.0 per cent, or -2.3 per cent in Canadian dollars given our currency's appreciation during that period,” says Dimock. “From 2011 to 2016, the TSX had an annual compound return of 5.2 per cent (including dividends) while the S&P500 had an annual compound return of 12.4 per cent, or 17.3 per cent in Canadian dollars. So the Canadian market performed really well from 2000 to 2010 due, in part, to the expansion in commodity  demand from China, but the U.S. market has outperformed Canada's post the financial crisis.”

Adds Oscar Belaiche, Toronto-based senior vice-president and portfolio manager at 1832 Asset Management L.P., which oversees the Dynamic Fund family on behalf of Scotiabank: “During the period from 2000 to 2010 the U.S. had a lot of issues while Canada skated through, the big reason being resource outperformance. Canada also avoided the steepness of the recession that began in 2008, largely because our banking system was solid. The U.S. was hit hard, but if you look at the period from 2010 to 2016, the U.S. has done much better than Canada.”

Brodeur agrees that Canada might have done much worse following the 2008 recession, were it not for our banks. “Our banking system did not collapse, and we didn't have the same implosion in our index as in the rest of the world,” he says. “Our banks are now back to new highs while in the U.S., for example, Citigroup Inc. was US$557 before the recession and it's now $57, or ten cents on the dollar. Our banking industry served Canada well.”

As for small/mid-cap equities, which outperformed their broader market counterparts globally as well as in Canada, Belaiche says this is to be expected given these investments' size and their risk/reward profile.

“It's the denominator effect,” he says. “When you're smaller to start with, it's easier to grow bigger. There's more risk in small caps, but that means more potential for higher returns. The small-cap market is more inefficient, too, and that creates opportunities for active managers. But you need good managers to find good investments — they're the ones making the calls and driving fund performance.”

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