The Portfolio Doctor

By David Cruise and Alison Griffiths
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Last week we walked Elizabeth F. through the process of selecting an asset allocation. The self-described "serial investor" has had as many as seven investment accounts, though she has now winnowed them down to three RRSPs with $78,000 invested in 19 different funds.

Elizabeth is 42 and a single parent with a 13-year-old son. She wants to simplify her portfolio with one account and fewer funds.

Elizabeth is going to transfer all her funds into one self-directed account at one of her discount brokerages. Her next big challenge is pruning her list of funds. Nine of the 19 she holds carry deferred sales charges. The DSC schedule on five of them has expired. Another five funds are no load funds.

Having ten funds that Elizabeth can sell without incurring a redemption fee certainly makes life easier and cheaper. Last week we told Elizabeth to group the funds in two lists, those with DSC fees and those without. Then she needs to group them again by asset class or sector.

Elizabeth has seven Canadian large cap or large company equity funds, which is six more than she needs. We can't imagine what possessed her to accumulate so many. She should aim for only one fund, ideally the best, in a given sector or asset class.

On her Canadian large cap list she has four funds with no loads, BMO Equity, Altamira Canadian Value, Altamira Equity, TD Dividend Growth and three with deferred sales charges, AGF Canada Class, Fidelity Canadian Large Cap and AIC Advantage.

Elizabeth should not be wedded to funds because they carry DSC fees. Better to dump a fund, pay the fee and put the money to good use somewhere else than hang on for years if it has been a long term underperformer.

An easy way to check a fund is through the Star's site. Go to www.thestar.com, click the Business tab and then the Fund Lookup tab at the top of the screen. Type in the fund's name and pull up the Quicktake Report. The page which first appears, Overview, allows you to look at a chart comparing your fund's performance with the peer group and the benchmark.

Without going to much more work you can gauge the performance of a given fund. If your fund's line is consistently below the peer group and index line on the chart then you have an underperformer. There are a number of other criteria to judge funds but Elizabeth needs simplicity. And this one-step process for each of her funds will help her do the necessary pruning.

Looking at her equity funds, Altamira Canadian Value and Altamira Equity are clearly at the bottom of the class, consistently lagging both their peer group and the benchmark index, in this case the S&P\TSX Composite. They are sell candidates and because they are no load, there is no redemption fee involved.

Fidelity Canadian Large Cap is also an underperformer, though not as much a laggard as the Altamira funds. The same is true of AGF Canada Class. AIC Advantage also belongs to the back-of-the-class gang though this fund holds a much higher percentage of non-Canadian companies. Still, for simplicity's sake we will include it with the others.

We can't determine what Elizabeth's redemption fees are going to be based on the documents she provided, but she can call the brokerage firms where her accounts are held to determine that information.

BMO Equity is a better performer in the Canadian equity class. Morningstar Canada (www.morningstar.ca) gives it a three star rating, which isn't brilliant. It doesn't outperform the index but it does come close and it also stays with the average performance of its peer group. There is no penalty to pay if Elizabeth sells, since it too carries no load.

Either by luck or design Elizabeth does have a winner in Canadian equity. TD Dividend Growth has earned a four-star Morningstar rating and it has a moderate management expense ratio of 2.2 per cent. It also has performed in lock step with the benchmark index over the past three years.

It makes sense for Elizabeth to sell her lower quality Canadian equity funds and re-invest the money in the TD fund. If the deferred sales charges on her load funds are onerous she could consider selling the allowable 10 per cent each year, without incurring a penalty. (Typically deferred sales charges start at 6 per cent and decrease 1 per cent for each year the fund is held.) However, in the long run, she may be better off absorbing the fee and aiming for better performance in the future.

The next question is, how much to invest in the Canadian equity asset class? Let's assume Elizabeth chose an allocation of 60 per cent (also 30 per cent bonds and 10 per cent cash). That means $46,800 of her $78,000 will be invested in equity. Interestingly, she considers herself a conservative investor yet has 75 per cent in equity now.

And let's say, of that $46,800 she decided to invest 25 per cent in Canadian large companies, 25 per cent in US large companies, 25 per cent in a broad based European fund, 10 per cent in Canadian small companies, 10 per cent in US small companies and 5 per cent in China. She is interested in China because it is her country of birth.

This is just a sample allocation but it shows how she can divide up her funds. Sticking with the example, Elizabeth would put $11,700 into each of her Canadian, US and European funds of choice, $4,680 each into Canadian and US small company funds and $2340 into a China fund.

Elizabeth also owns three Canadian natural resource sector funds which have performed well in the hot energy market of late. She could pare them back to one fund and reduce the amount she has in this sector.

However, since Elizabeth has duplication with TD Dividend Growth, which holds a number of the companies that are also held in the resource funds; she might consider selling all three. She will still have exposure to resources without the risk of so much invested in a single sector.

We suggest Elizabeth doesn't try to do everything at once. Deal with the Canadian equity funds first then move on to the resource funds and so on. There's no magic solution to this portfolio closet cleaning, just a lot of leg work. But in the end clean and simple wins the day for the average investor.