Canada's target-risk trend

Our study shows Canadians are pouring their money into target-risk funds whether they perform well or not.

Jeffrey Bunce, CFA 20 June, 2016 | 5:00PM
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Jeffrey Bunce: When we take a look at the mutual fund industry in Canada and ask ourselves what has been the dominant trend over the past five to six years and where has the money been flowing, the answer is, into target-risk funds. In fact, target-risk funds have been outselling standalone funds at a 6 to 1 clip since the start of 2010. In total, target-risk funds now make up approximately 32% of the industry total. Because of this, competition in this space has been intense.

We've taken a look at the management-expense ratio of a sample of 30 medium-risk funds from different programs and compared it to the cost of their underlying holdings. A majority of those funds, 23 in fact, are charging more than what can be explained by their underlying holdings. A few were charging about the same and a couple were charging less. Overall, the average upcharge is about 32 basis points. While it may be that the benefits inherent from the construction of these funds are worth the cost, the simple math of investing means that the lower-priced funds will have an advantage over the higher-priced ones.

The performance of target-risk funds has been mediocre at best. Out of a sample of close to 230 target-risk funds very few achieve a Morningstar rating of 4 or 5 stars, while a disproportionate amount receives a star rating of 1 to 2 stars. While we're not entirely sure why this is the case, we hope further research will shed some answers on this. What we do know, though, is that asset flows have been insensitive to performance. Essentially, funds that have 1 or 2 stars still receive positive flows. This is in stark contrast to standalone funds where, generally, funds that have a rating of 3 or less all experienced outflows.

For more of our research on target-risk funds, please click on the link below. Thanks for watching.

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About Author

Jeffrey Bunce, CFA

Jeffrey Bunce, CFA  Jeffrey Bunce, CFA, is a senior investment analyst for Morningstar’s Investment Management group.

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