Finally, some good news for fund investors

By Mark Noble | April 2, 2009 | Last updated on April 2, 2009
4 min read

It could be the great sucker’s rally — or maybe, just maybe, the markets have found a bottom. Either way, your client’s may have recovered a lot of money last month, according to data from Morningstar Canada.

In sharp contrast to two previous months, which saw mutual fund losses troll record depths, 20 of the 24 fund Morningstar indices tracking equity categories gained 5% or more last month. Five of them had double-digit returns, preliminary performance data reveals.

“Equities rose for the month as U.S. Treasury Secretary Timothy Geithner provided more detail on his government’s proposal to get toxic assets off the balance sheets of large banks, and described plans for new, tougher regulation of capital markets,” says Al Kellett, fund analyst for Morningstar Canada.

Even more remarkable is the comeback in the financial services industry. In Canada, the S&P/TSX Capped Financial Index rose 12.9%, and the Financials sub-index of the S&P500 did even better with a 17.7% gain, according to Kellett.

“Confidence in the financial services sector rose as some of the largest banks in the United States, like Citigroup, Bank of America, and JP Morgan, announced a profitable start to the year,” Kellett says. As a result, the Morningstar Financial Services Equity Fund Index had its best monthly performance in nearly a decade with a gain of 11.1%, tied for second best with the Morningstar Precious Metals Equity Fund Index.

This is an important development, given that many market commentators insist ascertaining a bottom will be necessary for any stabilization of the financial markets. So while using the word “excited” may be an overstatement, those who specialize in financial stock picking are expressing guarded optimism.

According to Chris Lowe and Greg Placidi, both senior vice-presidents and portfolio managers at AIC Limited — a firm with historically strong weightings in financial services — things are looking up in the financial service valuations.

As Lowe puts it, investors are starting to re-evaluate, particularly the large financial institutions, as businesses that may survive and have future earnings. Stock prices on many of these firms currently reflect a strong probability of corporate failure.

“If you can determine that of course this business is going to survive, then you can focus on what the earnings are going to be,” Lowe says. “That volatile period of debate as to whether these companies are going concerns or gone concerns [seems to be ending].”

Lowe says investors are emboldened by the fact that some U.S. financial service giants are beginning to look at ways to return funds they borrowed from the U.S. Troubled Asset Relief Program — a possible sign companies are feeling confident about their future prospects and don’t want to be handcuffed by government interference.

Lowe notes the firms that want to hand back the funds are the ones who can afford to hand them back, and see the advantage of not having the government on their books. “These companies are saying ‘we want to show you our businesses have been run better than Citigroup and AIG and we haven’t got the same problem and we want to be able to move forward on that.’ This leads analysts to examine just how much business potential is out there, and to reassess the earnings we are pricing these companies at,” he adds.

In Placidi’s opinion corporate bond spreads have also flattened, another sign analysts and investors feel an acceptable amount of default risk has been priced on financial services companies. Large insurance companies are also being able to go to the markets and fund their capital requirements.

“[Apart from AIG] not a single insurance company in Canada or the United States has gotten a dime from the government. While share prices have just been hammered, we’ve actually seen the life insurance industry weather this storm with no direct government inflow quite well. That’s evidence the credit markets are beginning to unfreeze,” Placidi says. “We’ve also noticed the corporate bond yields have stopped rising. We saw massive rise in the yields on commercial bonds, from basically last January all the way up to December 31, 2008. Every quarter, yields went up and up, all the way through the fourth quarter. That’s flat now. It’s hasn’t come down much but at least it’s flat.”

As Placidi notes, the financial services will likely never go back to the highs it experienced when leveraged balance sheets were the norm, but the worst may be over, and for investors that’s enough right now to get share prices moving in the right direction.

Placidi agrees analysts are still keeping their earnings forecasts low on significant financials — instead of pricing them at a 10 to 15 times earnings multiple they’re now getting around three to six times earnings.

Morningstar points also points out that emerging market equities, most notably equities in China, saw a substantial rise in performance last month.

Greater China Equity was the top performer among all fund indices in March with a 13.8% gain, reflecting a similar return by the Shanghai Composite Index. Other emerging markets such as Korea, Taiwan, and Mexico also posted double-digit gains contributing to good returns for the Emerging Markets Equity (10.9%) and Asia/Pacific ex-Japan Equity (10.2%) fund indices.

Morningstar also notes the past month was the first time since January 2007 that all equity fund indices were in positive territory. Among core asset categories, Canadian Equity was up 7.9%, U.S. Equity was up 7.2%, Global Equity, 6.2%, and International Equity, 5.9%.


Mark Noble