Investors continued to flock to Canadian balanced, dividend and income trust funds during the past RRSP season. Sixteen of the top-selling funds — by net new money (gross sales minus redemptions) —
excluding money market funds, fall into these categories, according to data from the Investment Funds Institute of Canada. Two others are Canadian bond funds.

That leaves just seven equity funds — three Canadian, three global and one U.S. — and even that’s deceptive. Most of the increase in two of the equity funds, MIX Canadian Large-Cap Value Class and MIX U.S.
Large-Cap Growth Class from Manulife Investments , were the result of mergers with Maritime Life funds that had been managed by outside managers. Neither of these funds has had above-average performance recently.

If the two Manulife funds are excluded, the next two to join the list are Dynamic Mutual Funds Ltd. ’s Dynamic Dividend Income and Manulife’s Elliott & Page Corporate Bond — bringing the total balanced, dividend, income trust and bond funds in the top 25 in net sales to 20.

Analysts don’t think the pursuit of income will end any time soon, although it may moderate. Investors were spooked by the technology collapse in 2000-01 and are still uneasy about stock markets. But as time passes, that nervousness will wane, says Dan Richards, president of Strategic Imperatives in Toronto.

Now, investors feel that they lose nothing by investing in income products, believing the returns they get are as good as the returns they get from equity funds — but with more safety, says Richards. This is partly because they don’t understand the risk of some income products, particularly income trusts.
But it’s the perception that matters. However, if Canadian equities have a third good year or interest rates rise a couple of percentage points, or both, that could change.

When interest rates rise, as is expected, returns from many of these products will moderate as the value of their fixed-income holdings falls. At that point, investors may decide it’s time to take some of their profits from income products and put them into equities, says Dwayne Dreger, vice president of corporate affairs at AIM Funds Management Inc. in Toronto.

Fidelity Investments Canada Ltd. already
sees more interest in equities, says Kim Flood, vice president of external communications. If 2005 turns out to be a good performance year for growth funds, this trend could accelerate, but it depends on upward momentum in the stock markets.
Flood points to research that shows growth managers are finding opportunities, while value managers are having difficulty finding new ideas.

There were some hopeful indications in February, which saw the first positive net flows (net new money, plus transfers in and minus transfers out) for the 11 months ended Feb. 28 for Canadian equity funds and for six months for European and emerging-markets funds, says Pam Byroe, manager of data systems at Investor Economics Inc. in Toronto. However, she notes, balanced funds peaked in popularity, with the highest net flows — $1.2 billion in February — since 1998.

Foreign equity funds have generally fared worse than Canadian ones. “There’s a definite preference for Canadian securities,” says Dan Hallett, president of Dan Hallett & Associates Inc. in Windsor, Ont. “This is partly the result of adverse currency impacts on returns on foreign funds, but it is also fuelled by the income trust boom, which is uniquely Canadian.”

The No. 1 selling fund was Trimark Income Growth, attracting a net $649 million from November to February, followed by RBC Asset Management Inc. ’s RBC Monthly Income Fund at $624 million.

Dreger attributes the success of Trimark Income Growth to its “relatively conservative investment thesis, as well as low turnover, even for a balanced fund, and a relatively low MER of 1.64%.” It has been a consistent performer, with above-average performance for 15 years, he says.

RBC Monthly Income has had good performance in recent years, as have the other five Canadian balanced funds on the list, except Franklin Templeton Balanced Growth and CI Harbour Growth and Income, which were below average in 2003 but were second- and first-quartile, respectively, in 2004, according to Morningstar Canada data.

There were six Canadian dividend funds on the list, with the top two from BMO Investments Inc. — BMO Monthly Income and BMO Dividend. Rather surprising, many of these haven’t had good performance recently. The exception is BMO Dividend, which was first- or second-quartile in 2002-04.