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Portfolios of funds at a glance

Portfolios of funds at a glance

Portfolios of mutual funds, or “funds of funds,” are growing in popularity across Canada. Why have we taken such a shine to these investments?

According to figures published by the Investment Funds Institute of Canada (IFIC) early this year, assets held by Canadians in mutual funds grew by more than 10% in 2017. However, within the range of funds on offer, the “fund of funds” class showed asset growth of almost 15%, while assets in stand-alone funds grew by only 8%. In fact, about two-thirds of mutual funds purchased in 2017 were funds of funds.

How can we explain these figures? Here’s a 5-point overview of the fund of funds.

The mutual fund industry in Canada
  1. What is a fund of funds?
    Also called a “portfolio of funds”, a fund of funds is different from a stand-alone fund in that it isn’t invested directly in securities such as stocks and bonds. Instead, it holds a variety of stand-alone funds; these stand-alone funds are invested in the market. This is also different from a “balanced” fund, which is invested in various asset classes but, for the most part, holds securities directly.
  2. A product focused on diversification
    With this type of product, mutual fund companies enable individual investors to diversify their investments among different asset classes with a single transaction and the same basic amount that they might invest in a stand-alone fund. To achieve an equivalent level of diversification, an individual, with the help of his or her mutual fund representative or financial security advisor, would have to purchase a large number of different funds. Many people prefer that approach in order to choose particular funds themselves and manage their own asset allocation. But a portfolio offers an alternative for those who prefer to keep things simpler.
  3. A multi-manager approach
    Since each portfolio consists of several funds, it ends up being managed by several managers, too, each one favouring a specific investment style, for example, “growth” investing or “value” investing. This multi-manager approach is generally thought to provide an additional level of diversification.
  4. A portfolio for every investor
    A portfolio of funds will usually be characterized by a specific risk profile, ranging from conservative to aggressive. So an investor can determine his or her own profile and then choose to invest in a corresponding portfolio knowing that, in principle, the portfolio’s asset allocation will match the risk level that the investor is willing to tolerate.
  5. Regular rebalancing
    Finally, to ensure that the portfolio remains aligned with its risk profile, the company managing it will look after rebalancing the asset allocation regularly to adjust for the variation in returns posted by the underlying funds. This means that the individual investor doesn’t need to do the buying and selling required to maintain the target asset mix.

These features give us some insight into why a large number of investors opt for this solution, at least for the core of their portfolio, which can then, if desired, be rounded out with more targeted investments. However, it’s important to realize that funds of funds generally have somewhat higher management fees than stand-alone funds. As well, if there is some overlap in the asset classes prioritized by the underlying funds, the investor might end up having invested repeatedly, although indirectly, in certain securities, which would not necessarily improve the portfolio’s asset diversification.

This may be why, despite the appeal of funds of funds, many mutual fund representatives and financial security advisors prefer to help their clients build individualized portfolios using stand-alone funds. The pros and cons of each approach can be discussed by client and advisor in order to decide which of the two options would be most appropriate for the client’s needs.

 

The following sources were used in preparing this article.
Finance et investissement, « Comprendre le profil de risque », December 22, 2017.
IFIC, « Industry Overview », December 2017.
Investopedia, « Funds of funds ». « Rebalancing  ».
Wikipedia, « Funds of funds », December 4, 2017.