Growth-oriented Mutual Funds￼￼
Growth-oriented mutual funds offer investors the opportunity for capital appreciation. Typically these funds are suitable for investors with long time horizons and higher risk levels. Growth-oriented mutual funds can range from steady growth to aggressive or speculative growth. Although index funds and fund of funds are not separate categories (instead they will fall under one of the existing categories), it is important to understand how these funds work.
Investors who are seeking higher returns and can tolerate a greater amount of risk will be interested in growth-oriented mutual funds. These funds experience greater fluctuation in their pricing and subsequently in their returns. Individual growth-oriented funds also vary in their risk levels. As with other mutual funds, the underlying securities in the portfolio determine the level of risk.
We will explore various equity funds as well as briefly discuss some specialty funds in the industry.
- equity funds
- Canadian dividend funds
- Canadian equity funds
- global equity funds
- International equity funds
- sector funds
- specialty funds
- labor-sponsored investment funds
- real property funds
- commodity pools
How Equity Funds Work
There are many categories of equity funds, ranging from mutual funds that invest in a diversified portfolio of companies to ones that invest in specific economic sectors, countries, or regions. Portfolio managers may also invest based on the market capitalization or the size of the companies. Market capitalization is defined as the total market value of a corporation’s outstanding shares. Generally, there are three market capitalization groups:
- small market capitalization (small cap) – smaller companies (e.g. between $100 million and $1.5 billion)
- medium market capitalization (medium or mid-cap) – medium-sized companies (e.g. between $1.5 billion to $5 billion)
- large market capitalization (large-cap) – large, established companies, often called a blue chip (e.g. over $5 billion)
The market capitalization that defines small, medium, and large-cap companies vary across investment fund managers. The above amounts are given as examples.
How Canadian Dividend Funds Work
Canadian dividend funds provide investors with periodic dividend income by investing in shares of corporations that regularly pay dividends. The investment objective is to provide income and long-term capital growth.
Dividend-paying corporations are typically large, established businesses with a history of providing steady dividend payments.
The common and preferred shares held in a Canadian dividend fund generate tax-preferred dividend income. Dividends from Canadian companies benefit from the dividend tax credit. This credit reduces the amount of tax the investor pays on their dividend income.
|Dividend funds are a moderate-risk investment. They are at higher risk than bonds because the market valuation of common shares fluctuates as market conditions and investor sentiment change. However, dividend-paying shares experience lower volatility than non-paying dividend shares.|
How Canadian Equity Funds Work
Canadian equity funds invest in securities of Canadian companies. The investment objective is long-term capital growth.
|Canadian equity funds invest the majority of their portfolio in Canadian companies. The portfolio managers seek to create a diversified portfolio by selecting individual securities that meet their criteria. Investors may receive income from the mutual fund that is tax-preferred in the form of dividends and capital gains.|
How Global Equity Funds Work
Global equity funds are free to seek opportunities in any country or region, free of geographic restriction, in their pursuit of long-term capital growth.
Global equity funds can invest in securities of corporations throughout the world including Canada and the U.S. The geographic allocations for individual global equity funds vary from one another since the portfolio managers determine where the best opportunities lie for their respective mutual funds. Some global equity funds may be more heavily weighted in developed countries while others find better prospects in emerging markets.
Global equity funds typically involve more risk than Canadian equity funds. These risks associated with foreign countries include:
- fluctuations in the currency exchange rate
- unstable political environment
- economic uncertainties
How International Equity Funds Work
International equity funds invest in securities of corporations outside of North America. The investment objective is long-term capital growth.
In contrast to global equity funds, international equity funds hold only securities issued by foreign corporations.
International equity funds are typically at higher risk than global equity funds because they are completely invested in foreign companies. Therefore, international equity funds are more greatly impacted by the currency, political, and economic risks associated with the countries they chose to invest in.
For emerging and developing countries, these risks can be magnified because their markets are less regulated than markets in developed countries.
NOTE: Global equity funds are only partially exposed to the risks identified above since some of their holdings are in domestic corporations.
How Sector Funds Work
Sector funds are mutual funds with a narrow investment focus. The investment objective is long-term capital appreciation.
According to their investment mandate, sector funds concentrate their holdings in a particular industry or sector. There are a number of different categories of sector funds. Some examples include:
- technology funds
- financial services funds
- healthcare funds
- natural resources funds
- precious metals funds
|Sector funds’ narrow focus makes them higher risk compared to diversified equity funds that have broader exposure to different business sectors or regions. These funds have the potential of offering extremely high returns but with huge downside risks.|
How Labour-sponsored Investment Funds Work
Labor-sponsored investment funds (LSIFs) provide money for Canadian start-up companies. They are also known as labor-sponsored venture capital corporations (LSVCCs). The investment objective is long-term capital appreciation, with tax benefits in the form of tax credits.
How Labour-sponsored Investment Funds Work
LSIFs provide capital to small- to mid-sized Canadian start-up companies in exchange for ownership shares in the company.
The federal government offers unitholders a 15% tax credit on a maximum of $5,000 investments per year. In addition, some provincial governments offer a further 15% tax credit.
IMPORTANT: The Government of Canada announced in the 2013 Federal budget, that the 15% federal tax credit is to be eliminated gradually, ceasing by 2017. Provincial tax credits have also undergone some changes, with each province having its own amendments. For instance, Ontario eliminated the tax credit as of 2012.
Investors must hold on to LSIFs for eight years to maintain the credits. Otherwise, the credits must be returned to the government.
While some companies that receive funding from LSIFs have been successful, many others fail within the first few years.
|The low liquidity of LSIFs, combined with the fact that they are invested in high-risk companies makes LSIFs a high-risk investment choice. Investors should have high-risk tolerance and a long investment time horizon.|
How Real Property Funds Work
Real property funds invest in real estate properties. Investors receive returns from rental income, as well as capital gains from properties sold at a profit. The investment objective of real property funds is a steady income and long-term capital growth.
Unlike other mutual funds, these funds are not priced daily. Real property fund values are based on the appraisal value of the properties held in the portfolio, which do not change daily.
Unit prices are set monthly or quarterly. Because unit prices are set less frequently, investors may only be able to redeem the funds at specified times. Also, if the fund does not have enough cash on hand, the redemption requests may only be partially filled.
|These funds are high risk because they are invested in one business sector, rather than holding a diversified portfolio. In addition, real property funds are less liquid than other types of mutual funds since investors may not be able to convert their investment into cash when they want.|
How Commodity Pool Funds Work
Commodity pools are mutual funds that are permitted to use or invest in specified derivatives and physical commodities beyond what is permitted by National Instrument 81-102. These funds are governed by National Instrument 81-104. The investment objective is capital growth.
Commodity pools are similar to other mutual funds except they are able to employ alternative trading strategies for their portfolios. Commodity pool managers engage in speculative trading by investing in:
• specified derivatives
• physical commodities
Some of the investments that may be found in a commodity pool are commodity futures and forward contracts for grains, meats, metals, energy products, and coffee.
Commodity pools are high-risk investments because they involve speculative trading, which is a strategy of making quick profits by buying and selling assets in a very short period. As a result, commodity pool fund performance can be extremely volatile.
IMPORTANT: Please note that a mutual fund registration is not sufficient to sell these products. Additional proficiency and registration are required.
Index funds base their investment mandate on a specific market index. These funds seek to replicate the performance and return of a market index by investing in the same securities as those held by the index, either by investing in them directly or by using derivatives.
For instance, a Canadian index fund that is meant to match the performance of the Standard & Poor’s / Toronto Stock Exchange (S&P/TSX) Composite Index, would attempt to invest in the same portfolio of securities as those held in the S&P/TSX Composite Index.
Index funds fall into different mutual fund categories depending on the underlying securities of the fund. An index fund that is tracking the S&P/TSX Composite Index would be part of the equity fund category while an index fund that tracks the DEX Universe Federal Bond Index (Canadian market benchmark for bonds) would be part of the fixed income mutual fund category. The risk classification will depend on the securities held in the portfolio.
The value of the mutual fund changes in line with the holdings of the index. While the intention of these mutual funds is to replicate the return of a specific market index, its return will not perfectly match the index. This discrepancy is called the tracking error. An index fund’s return tends to lag that of the specific market index since there are costs associated with managing the index fund that are not applicable for the market index. Furthermore, the index fund may only hold a sampling of the securities of the market index. The portfolio manager tries to conform as closely as possible but it may not always be possible to reproduce the identical basket of securities.
Fund of Funds
A fund of funds (FOF), also called a wrap fund or a managed portfolio solution invests in a basket of mutual funds from the same investment fund manager. Essentially, the FOF creates a diversified portfolio to meet a specific investment objective using mutual funds instead of individual bonds and equities.
|These investments are suited for investors who want a simple solution. These investors do not have the time or expertise to customize a portfolio of their own, nor do they have the discipline to rebalance their portfolio.|
Fund of funds has the following characteristics.
FOFs offer investors the convenience of a pre-set investment portfolio. They establish a target asset allocation of cash, fixed income, and equities to meet its investment mandate.
Investment fund managers usually offer a series of managed portfolios that range from conservative to moderate to aggressive growth. Since the funds may hold a mix of stocks and bonds, the FOFs may provide steady income or long-term capital growth, or a combination.
The risk level varies according to the asset mix of the FOFs. The diversified nature of these funds makes them lower risk than stand-alone mutual funds, which invest directly in stocks and bonds.
Multiple portfolio managers
FOFs employ a multi-manager approach, which means the investor gets the professional expertise of a portfolio manager from each mutual fund held in the fund of funds. This way, the investor can get professional investment management across asset classes, sectors, countries, and investment styles.
FOFs automatically rebalance their portfolios to adhere to their target asset allocations. For instance, if the value of equity holdings increases, the portfolio manager may reduce the equity holdings to return the fund to its target asset allocation within the fund of funds.
As a dealing representative, it is important for you to be mindful of the FOFs fee structure. There may be two sets of management expense fees involved:
- the management fees of the fund of funds
- the management expense fees of the underlying mutual funds
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