WHEN the term "flexibility" is mentioned in a discussion regarding investing, most people understand that it references the ability to choose certain investment options over others.
Unfortunately, many investors do not understand the inflexible nature of the wealth management world and, in some cases, the severe restrictions that essentially handcuff portfolio managers.
When the market, or even a particular sector, is falling significantly most would logically say "get out of the way" and "find somewhere else to park your money."
The trouble is some investment managers are bound by their mandate (or pre-defined investment strategy). This wouldn't be a problem if the mandate was developed with the flexibility to raise cash in riskier times and to reduce exposure to certain sectors if needed.
In reality, many investment mandates (particularly with mutual funds) require the manager to stay almost fully invested, sometimes in sectors that should be avoided, even when conditions are poor.
Ideally, what you want is an investment manager that can "go anywhere" so to speak. As mentioned earlier, many mutual funds in Canada have strict guidelines which they must follow when managing their mandates.
Many funds are only able to raise cash to a maximum level of 10 per cent. This could result in over-exposure to stocks if there were a significant market correction. You need a flexible portfolio manager should there be heightened risk in the markets, so that your portfolio is protected from the full weight of a downturn.
This brings us to another issue - sector funds. Mutual funds can be categorized by the type of investment they focus on, such as bond funds, equity funds, REIT funds, international and even resource funds. Owning a mutual fund that focuses on one-single sector when that sector is doing well can be terrific, the problem starts when that sector falls out of favour (which is inevitable).
For example, a number of resource funds had a great run up until 2010 or 2011.
These funds have since fallen by 30-50 per cent or more in some cases. This was primarily due to the sector falling out of favour and the portfolio manager being unable to do anything about it.
Due to the inflexible structure of most funds, they are forced to remain in underperforming sectors, which handcuffs the manager from shifting into better performing areas of the stock market.
So how do you know if the investment manager you are using is restricted or flexible?
Ask questions such as:
. How much cash can this fund manager raise if there is risk in the markets?
. Are there restrictions on how much this fund/ portfolio is able to invest in bonds or stocks?
. How often do you look at my holdings and rebalance them?
. Can this portfolio invest internationally?
. Does this fund have to stay in a certain sector such as gold or oil
With the recent volatile market conditions, we have seen some managers do extremely well, only to lose money in other periods. In our opinion, this inflexibility is the single largest contributor to poor performance in mutual funds, and is why so many Canadian investors haven't made great returns over the past five years. Our philosophy is that all client portfolios should be flexibly managed, a strategy that has proven to be much more successful in the current market environment.
Lori Pinkowski is a portfolio manager and senior vice-president, private client group, at Raymond James Ltd., a member of the Canadian Investor Protection Fund. This is for informational purposes only and does not necessarily reflect the opinions of Raymond James. Lori can answer any questions at 604-915-LORI or lori.pinkowski@raymondjames. ca. You can listen to her every Friday on CKNW at 5: 35 p.m.
