Mutual funds face paradox of thrift

By Scot Blythe | February 13, 2009 | Last updated on February 13, 2009
3 min read

As consumers tighten their belt in the face of recession, savings rates could jump from their current 3% to the double digits that prevailed in the 1980s.

That would be good news for banks, money market funds and government bond issuers, says Toronto consultancy Investor Economics in its year-end wrap-up of the mutual fund industry. But it would spell trying times for lenders and long-term investment funds: a fund industry version of the paradox of thrift, as consumers place return of capital above return on capital.

From 2002 to the end of 2007, household wealth in Canada grew by almost a trillion dollars, well ahead of a GDP boost of only $383 billion. This disparity could be interpreted in two ways, according to Investor Economics. Either consumers were expecting faster GDP growth, or financial assets were overvalued.

The year 2008 seems to have supplied the answer: $300 billion was lopped off of Canadians’ financial wealth in 2008, with half of that coming from falling investment fund values.

This parallels what happened in the 2000-2002 bear market, which saw investment funds decline as a percentage of financial wealth from 31% to 28%. In addition, after four years of positive flows of $24.8 billion a year, 2008 saw an outflow of $16.7 billion.

Conservative references are also making for a different asset mix. In 1998, 34% of inflows were to pure equity funds, and 38% to short-term funds. Last year, 25% of gross sales went to pure equity funds and 49% to short-term funds.

Segregated funds have fared better than the rest, and are indicative of an ongoing shift in the funds industry from products to solutions. Those solutions include managing market risk and interest rate risk; generating investment income; minimizing tax; and higher-quality investment guidance. These needs underlie products such as wrap funds, lifecycle funds, segregated funds (including those with guaranteed minimum withdrawal benefits), fund-linked notes and T-class funds.

Independent financial advisors have seen an erosion in their dominance over other sectors; taken together, bank-branch salespeople and advisors now have a slightly greater share of mutual fund assets at just over 27%, with full-service brokers in third place, at 23%.

On the manufacturing side, banks and credit unions have grown much faster than independent manufacturers. At the beginning of the decade they controlled one-fifth of mutual fund assets; now it’s almost one-third.

While there has been a flurry of stimulus announcements around the world to bolster faltering economies, Investor Economics suggests that retail investors won’t return to equity markets as quickly as institutional investors will. Second, interest rates will likely remain low as investors become savers rather than borrowers. In contrast with that, however, is that, as the population ages, significant numbers of Canadians need to accumulate and protect assets.

The good news in this is that investors are more aware of the need to have a financial plan. But a countervailing trend is increased worry about the resilience of financial institutions in a downturn.

All of this adds up to a challenging year ahead.

“It is evident that in 2009 it will not be ‘business as usual,’ and that investors are demanding a higher level of expertise (or a lower cost of advice) from their advisors and more prudent management from the companies entrusted with their assets,” Investor Economics warns. “It is not a problem for individual companies, but more an industry problem. The industry needs to find a way to restore investor confidence, and dragging out the 2008 RRSP campaign advertisements just won’t work.”


Scot Blythe