How to Choose a Mutual Fund
The Canadian market has more than 4,000 mutual funds. You can find thousands of types of funds on the Canadian market: bond funds, equity funds, sector funds, specialty funds, regional funds, diversified funds, balanced funds, index funds and many more.
This section provides a list of specific elements to be considered when you compare different mutual funds. Once you know the type of fund that suits you best, you can start "shopping around" by comparing funds.
For additional information, you can visit the web sites of the following organizations: Mutual funds Institute of Canada, the industry association for Canadian mutual fund companies, and the Autorité des marchés financiers NOTE - This link will open in a new tab., which is mandated to protect investor interests.
When choosing a mutual fund, you should consider the following aspects:
This is the most commonly used criterion for comparing funds. In most cases, the long-term return should be considered.
Quartile rankings are used to compare returns of funds in the same category. These rankings are published widely in newspapers and a number of financial Web sites.
Mutual funds have been classified into more than thirty categories by the Mutual funds Standards Committee, which is made up of media representatives, analysts and data publishers. This classification facilitates comparisons among funds with similar features.
Each fund category is broken down into four equal parts or quartiles. For instance, if a given fund category has 100 funds, each quartile will be made up of 25 funds. The 25 funds with the highest returns will belong to the first quartile, the next best 25 funds to the second quartile and so on.
Quartile rankings are compiled for each of the periods generally used for calculating fund returns: 6 months, 1 year, 3 years, 5 years and 10 years.
It is not advisable to give too much importance to quartile rankings for short periods such as six months or one year. Fund comparisons should rather be based on longer-term rankings (3 years or more).
Management fees and other costs related to investing differ from one fund to another, depending on portfolio requirements and other factors.
Mutual fund managers receive annual fees for their services relating to research, analysis, security selection and portfolio monitoring. These annual fees are calculated as a percentage of fund assets and generally vary between 1% and 3%.
This percentage depends on the complexity of the portfolio as well as that of the market in which the fund is invested. Management fees of an equity fund are thus higher than those of a money market fund.
Moreover, within the category of equity funds, specialty funds and international funds generally charge higher management fees compared with traditional Canadian or North American equity funds.
Similarly, higher management fees will usually be charged to a fund with several portfolio managers.
In the case of index funds, whose portfolios entirely replicate the make-up of the benchmark index, management fees are lower. This is because the management of such funds do not require any visits to companies, meetings with executives, research or investing decisions.
Other costs could be added to the management fees:
- front-end loads at the time of purchase, which are generally commissions paid to the salesperson;
- back-end loads at the time of sale. Back-end loads are regressive, that is, they decrease over time such that after a certain number of years, they are eliminated.
Desjardins Funds as well as those of the major Canadian banks carry no front- or back-end loads.
More and more investors today have ethical concerns about their investments. They do not want their money to be used to support tobacco manufacturers, military-related businesses or companies known for long-standing labour disputes.
Such investors like to support companies that share their values such as equal opportunity and racial non-discrimination, progressive labour relations, and environmental protection.
Ethical funds are intended for such investors. These funds avoid companies with operations that could potentially cause problems and invest in businesses that, in one way or another, contribute actively toward the improvement of our world.
You need to know the approaches used by different portfolio managers in order to ensure sound diversification of investments by management style. Management styles and approaches can vary from one fund to another as well as from one portfolio manager to another. The management style of a fund determines how securities are selected as well as the day-to-day investment decision process.
Under specific conditions, a particular style could produce better results compared with other styles. For example, portfolio managers with growth styles can thrive under conditions that are not favourable for value managers.
Therefore, you need to take into account management style in order to ensure sound diversification. By holding funds that are managed according to different strategies, you can optimize overall return potential.