December 2011

What to do with a mutual fund
that hasn't made money in years

By Don Eberley

ďAs God is my witness, I thought turkeys could fly."

- Mr. Carlson

There's an old financial expression which says that even turkeys can fly in a hurricane. This was aptly demonstrated during the booming 1990s, when many new mutual funds were released into the wind and virtually all of them took off brilliantly.

The corollary of this expression is that it's easy to tell the difference between turkeys and eagles when the wind stops blowing. When the stock market fell silent early in the new millennium, the eagles stayed aloft while the turkeys came plunging back to earth where they have been grounded ever since. Over half of today's eligible global equity funds have gone nowhere for the past ten years.

Ten years is a long time to go without making any money. And with previous sideways markets having lasted as long as 16 years (1966-1982) or even 25 years (1929-1954), many people have had enough. They are tired of raising turkeys.

Are you sure it's a turkey? How to tell using free online reports

Before chasing any mutual fund turkey around the barnyard with an axe, make sure it's not some poor innocent eagle who just flew down to use the washroom.

If the fund's 10-year performance chart ( shows no lasting gains since Y2K, start sharpening that axe. But if it finished above the CPI inflation line when measured in after-tax dollars, leave it alone. It is not a turkey.

If the Annual Report ( shows 300 stocks in the portfolio with virtually no cash, then you've got yourself a closet index fund which is likely to remain grounded for as long as the market remains flat. But if you see a more discriminating 30- or 40-stock portfolio, and maybe some cash as well, that's an encouraging sign that the portfolio at least has the potential to fly under its own power.

If the Management Report of Fund Performance ( consistently indicates more than 40% annual portfolio turnover, this suggests that the fund manager is flapping his arms too quickly and may never get off the ground. If consistently below 20% he might not be flapping hard enough; in fact you might want to check his pulse. 20-40% is about right.

These online resources also reveal how much money the fund is managing. This is important, because too much money can weigh a mutual fund down. A Canadian Equity fund carrying several billion dollars, for example, is difficult to manage without regressing to the index. It it simply too big to be different.

Is it likely to stay that way?

No matter what the data shows about a mutual fund's past, you must consider the future as well.

If the management team has recently changed, this could profoundly change the future direction of the fund for better or for worse. So too can changes of ownership, such as when an independent manager is taken over by a large fund company. This can put unwanted pressure on management to modify its strategy in some way, or it can provide them with greater resources and economies of scale. It can be good or bad, depending on the situation.

I keep tabs on the fund managers I use by subscribing to news feeds, attending their road shows and conference calls, meeting with company representatives, and talking to the competition. You never know what will turn up.

So it's decided: This turkey has to go. Now what?

Once you've decided that it's time for a particular mutual fund to go, the next step is to evaluate the potential selling costs and tax consequences. By definition a "turkey" should not have much in the way of capital gains to worry about, nor should there be any significant deferred sales charges if you've given it enough time. If there are extensive fees or taxes, you might want to put the axe down and think about what you're doing.

The final item on your checklist is to devise a rational exit strategy. While it would be nice to wait for the price to jump before selling, that might be like waiting for the federal government to balance its budget. At least try to avoid selling during a severe market panic, and whatever you do don't invest the proceeds in an eagle that is currently flying high. Try to find one returning from its washroom break.


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