Why investors have been seeking redemption

The mutual fund is for the most part the refuge of the amateur investor, and when the potash hits the fan, the amateur panics. As a result, the mutual fund business has taken a real hammering in this huge market downturn.

"Mutual funds always under-perform the benchmark. Retail clients always buy after the market goes up and panic when it is down," says a successful Toronto broker whose firm doesn't allow him to be quoted.

True to form, Canadians abandoned mutual funds in 2008 as the economy's woes grew.

Poor performance drove investors to cash in funds that invested in the stock market. As a class, mutual funds lost 20.4 per cent in 2008, according to the Investment Funds Institute of Canada (IFIC), which monitors fund performance. The numbers for many equity funds were much worse. And many hedge funds had terrible results or closed altogether.

Last year Canadian investors redeemed $14.2 billion in mutual funds They purchased a little less, so net sales of funds in Canada in 2008 were just $107.8 million. That compares to net sales in the boom year of 2007 of $33.5 billion.

"People moved onto the sidelines and bought any kind of guaranteed product," said Dennis Yanchus, manager of statistics and research at IFIC.

Yet Dan Richards, who runs a firm that advises people such as financial planners, says the mutual fund statistics are not as bad as they appear.

"The surface numbers on redemptions exaggerate how bad a year it was. What happened in the latter part of 2008 (and also in 2002) was a bit of a buyer's strike, as new money dried up," said Richards, president of Strategic Imperatives. "Yes, redemptions were up, but not nearly as much as the net redemption number would suggest, since this also reflects new money drying up."

Mutual appeal

Mutual funds have been attractive for amateur investors because they spread the risk of potential losses over a number of stocks. But that appeal has led to the development of a dizzying array of choices, and these days picking mutual funds can be tough. Depending on how you measure it, there are almost three times as many mutual funds in Canada as there are stocks on the Toronto Stock Exchange.

As of the last week in January, there were 1,517 stocks listed on the TSX and another 1,443 on the TSX Venture exchange, for a total of 2,960, But according to a source at the Robertson Index of mutual funds in Canada, "There were 9,820 mutual funds of all stripes in Canada, including hedge funds, pooled funds and ETFs."

"We monitor 2,015 mutual funds in Canada," said IFIC's Yanchus.

No matter which way you cut it, there is a lot of choice in funds. That means there's something for everyone, but it also means giant mutual fund conglomerates always have a winner to publicize even when other funds in their portfolio are doing poorly.

"Fund companies have so many different funds that there is always one that is doing well and so that is what they market and promote," says the Toronto stockbroker.

A notable problem with mutual funds is that in many cases they must be fully invested. It's a kind of institutional buy-and-hold policy.

One contrarian financial adviser says she recommends her clients avoid mutual funds.

"During long bull markets they attract assets and hide their overly expensive fee structure in above-average market gains, but as soon as the down markets come people soon realize that there is no one actually protecting the capital," says Danielle Park, of Venable Park Investment Counsel.

"Mutual funds, in their concept of diversification and affording the services of investment counsel for small investors, should be good. But sadly, they sold their souls to scale and leverage and marketing over fiduciary duty," Park said.

Market meltdown

While the 'buyer's strike' and the huge rise in redemptions is obviously linked to the meltdown in markets, as Park points out another underlying factor is fees.People seem to be able to ignore them when their investments are producing big returns, but notice them more when returns are negative.

Many investors, in particular smaller investors, like good news and don't have the stomach for losses.

And financial planners report most of their clients are losing.

"Mutual funds are down like everything else. Typically people are down 20 per cent, and if you're into things such as energy funds you could be down as much as 50 per cent," says Robert Abboud, a financial planner and author of No Regrets, a Commonsense Plan to Achieving and Affording your Life Goals.

"You've only made money if you've been into bonds," Abboud told CBC News.

His advice for the small investor is pick safer investments in a volatile climate.

"Avoid high-risk mutual funds that are based on a momentum style of investing. That's where the manager follows the sales of a company and projects that forward into three years," Abboud said. "I like value-based funds that really focus on buying companies at a discount."

For now, the momentum in the market and mutual funds points just one way, down.

Fred Langan is host of CBC News Business.