Benchmarking Problems
Canadian stock funds present challenge

Foreign content rules, and the variety of policies of its use have created a benchmarking problem for Canadian equity funds. The Investment Funds Standards Committee (IFSC) recently introduced the Canadian Equity Pure category in part to address this issue. However, issues remain in longer-term comparisons of Canadian stock funds.

Foreign content

Beginning in 1990, the Canada Customs and Revenue Agency (CCRA) granted permission to pension funds and Canadian mutual funds to invest in foreign property, up to 10 percent of book value. This limit rose by 2 percentage points per year, until it hit 20 percent in 1995. Finally, the limit was bumped up in 1999 and 2000 to 25 and 30 percent, respectively. Currently, the limit remains anchored at 30 percent.

While the Canadian equity pure category helps to address this issue, it's only a partial solution. For instance, prior to 1990 all Canadian equity funds in existence were 'pure' by the IFSC's definition since no foreign property was allowed in products eligible for RRSP and other tax deferred savings plans.

Canadian equity funds maximizing foreign content today requires a benchmark with variable weights of foreign content to reflect the variable limits over time.

Cash policy

As noted in this older article, policies on what to do with cash are all over the map. Some managers consider it their duty to invest in the asset class covered by its mandate. Others are of the opinion that cash should be held in the absence of investment opportunities that meet their criteria.

Foreign content issues aside, some managers are rarely, if ever full invested. During his fifteen-year career as a money manager, I estimate U.S. equity manager Larry Sarbit's average cash position at close to 20 percent. Jerry Javasky, manager of Mackenzie Ivy Canadian (among others) consistently seems to hold a similar cash position. Many others are in the same boat.

These seemingly perpetual cash positions should be incorporated into benchmarks against which performance is measured. The TSX Composite index, for instance, is a terrible benchmark for Ivy Canadian. With just a 53 percent current weighting in Canadian stocks and a historically low correlation to the index, it's a wholly inappropriate benchmark.

Changing policies and styles

Changes in money managers can result in a performance history which actually occurred under quite different investment policies, let alone different styles. One classic example is CI Canadian Equity fund. Jerry Javasky and Gerry Coleman managed this back in the 1970s when it was the United Canadian Equity fund. They don't hesitate to pile cash when opportunities become scarce. In 1992, Kiki Delaney took over. She tends to hold a bit of foreign content but well below the maximum - and tries to stay fully invested. The "foreign-content-maximizing" McLean Budden took over in 1999 and they tend to stay fully invested. Finally, Kim Shannon took over last year. She tends to hold very little foreign content and to stay fully invested.

This one fund's historical record is not only made up of four different management teams with diverse styles, but also of varying foreign content and cash policies (though the latter has been somewhat consistent for many years). This presents significant challenges when evaluating past performance. The simpler solution in this particular case is to look to the longer-term record of the manager - not always an option.

It's important to know that, sometimes there will be no suitable benchmark available for comparative purposes. In other cases, knowing a fund's history is very relevant to getting at least an accurate picture of past performance.