Gauging the 2006 performance of mutual fund families is a challenging exercise, given that Toronto-based Morningstar Canada introduced a new system for categorizing funds this past October.

Depending on the types of assets held, a particular fund may have shifted to a new Morningstar category from a traditional one developed by the Canadian Investment Funds Standards Committee, the system previously used by Morningstar and still employed by Globe Interactive, part of the Globe & Mail, which markets the Globe HySales software used by some to rate funds. A shift in fund category can have a marked impact on the overall performance of a fund family.

That said, some fund compa-nies show sterling numbers under either system. For instance, performance was very strong in 2006 at Phillips Hager & North Investment Management Ltd. of Vancouver, MD Funds Management Inc.of Ottawa, and AGF Mutual Funds Inc. and AIM Funds Management Inc. , both based in Toronto.

Each had 80% or more of assets under management in long-term funds performing in the first or second quartiles — whether measured by the new Morningstar or the conventional CIFSC/HySales categories.

The introduction of new categories does, however, make a huge difference to the performance records of some companies, particularly Fiducie Desjardins Inc. of Montreal and TD Asset Management Inc., Scotia Securities Inc., BMO Investments Inc. and Guardian Group of Funds Ltd., all based in Toronto. These fund families have below-median performance using the new Morningstar ratings — dramatically low for BMO and GGOF — but strong performance under the HySales system (see table).

Note that HySales has data for more funds than has Morningstar. In the case of GGOF, Morningstar data cover $5.2 billion in AUM in 29 funds vs HySales’ $5.5 billion in 32 funds. (Asset figures used in this story are from Morningstar.)

GGOF and BMO are the most affected by the category changes: with only 8.4% and 11%, respectively, of their long-term AUM in the first or second quartiles, according to Morningstar; both have 75.1% in the top two quartiles using HySales.

The main reason GGOF’s results are much better using HySales is that Morningstar has eliminated the “Canadian income trust” category and put income trust funds into a new “Canadian high-yield value” category, in which the median holding of trusts is 44%.

GGOF Monthly High Income Mutual and II funds hold 89% in trusts, so it’s no surprise that their performance in this new category is below median, given the drop in income trust valuations following the Oct. 31, 2006, announcement of changes in their taxation. And as the two funds account for $2.1 billion (or 39%) of GGOF’s long-term AUM as of Dec. 31, that pulled performance for the fund family way down.

GGOF Dividend Growth Fund, with $544 million in AUM and a 13.6% return for the 12 months ended Dec. 31, was also below median according to Morningstar but above median using HySales. Morningstar has put the fund into its “Canadian equity” category, which has 196 funds and a median return of 14.8%. The HySales “Canadian dividend and equity income” category has 192 funds and a median return of 12%.

In BMO’s case, two of its largest funds — BMO Monthly Income, with $5.7 billion of the $20.6 billion in total fund family assets as of Dec. 31, and BMO Dividend, with $5.5 billion — were below median according to Morningstar but above median using HySales.

In the case of Scotia Securities, Scotia Canadian Dividend Fund ($1.9 billion in AUM), Scotia Canadian Balanced Fund ($1.8 billion) and Scotia Canadian Income Fund ($1.4 billion) were all below median according to Morningstar but above median using HySales. Scotia Securities’ total fund AUM were $12.7 billion as of Dec. 31.

For TDAM, it was the ranking of TD Canadian Bond Fund, with its $8.3 billion in AUM (16% of $50.6 billion in total AUM), that is responsible for the big difference in that fund family’s performance. Again, Morningstar has it below median but HySales has it above.

The “I” version of TD Canadian Bond was not much below median, with a return of 2.6% vs the category’s 2.9% median, under the Morningstar system. The “A” version’s 2.2% return was fourth-quartile. This fund includes real-return bonds, which didn’t have a good year. However, Karl Schulz, vice president of TD Mutual Funds, is not disturbed; the fund had previously been first-quartile for more than 18 years.

@page_break@Nor is Schulz worried about TD Real-Return Bond Fund, which has $2.3 billion in assets and whose performance was also below median. It had been first-quartile for more than 12 years.

TDAM fund sales have remained strong, partly because of the launch of new global and international funds to round out the company’s offerings. Investors are looking for more options in the face of the expected dampening of returns from Canadian equities as a result of weaker resources prices, says Schulz.

Note that Investment Executive’s calculations include portfolio funds of funds, so there is some double counting. Usually, this doesn’t make a big difference in overall performance because the assets involved aren’t that large, but, in TDAM’s case, there’s about $10 billion involved. Without these assets, TDAM would have had 51.3% of long-term AUM above median using Morningstar’s new categories and 77.1% above median with HySales data.

Desjardins is a bit frustrated by Morningstar’s new categories because its performance shows marked improvement if the HySales categories are used. In 2004, Desjardins revamped its lineup, introducing new funds and new managers as well as changing the policies and mandates of other funds, says Mac Dubuc, vice president of marketing. He notes that 100% of its sales are generated by its asset-allocation programs.

For some companies, weaker performance quickly results in net redemptions, but others seem to be able to continue to sell well — at least, for a while. Mackenzie Financial Corp. has been near the bottom of the list for AUM in the first and second quartiles since 2003 but moved into net redemptions for long-term AUM only last May.

National Bank Securities Inc. of Montreal has also had a dreary record, but sales remain good, says Martin Lavigne, senior vice president for sales and products. The reason is that more than half its wealth-management AUM are in portfolio products, for which neither Morningstar nor HySales have data but which are performing well.

It’s the funds’ risk-adjusted returns and the way they work together in a portfolio that matters to National Bank Securities. Portfolio performance is also enhanced by the use of outside funds, says Lavigne, pointing to his firm’s use of products from Fidelity Investments Canada Ltd. in Toronto, which continues to post good numbers.

Lavigne, though, does admit that National Bank Securities was concerned about the performance of National Bank Bond Fund and recently replaced its management team. The fund has since seen improvement and expects to be second-quartile “very soon.”

On the other hand, AGF has suffered net redemptions even though its recent performance has been relatively good. In 2004, only 49.6% of its long-term AUM were in funds in the first or second quartiles. AGF’s problem has been psychological, with the loss of Brandes Investment Partners LP as manager of the hugely successful AGF International Value Fund in 2002 clearly upsetting advisors and investors. It wasn’t until 2006 that AGF returned to net sales.

AIC Ltd. of Burlington, Ont., AIM and Toronto-based Altamira Investment Services Inc. have had more typical experiences, going into net redemptions following weak performances. Altamira has now posted two consecutive good years, but AIC and AIM turned the corner only in 2006.

Sector allocation has been a big part of AIC’s underperformance in recent years, says president Jonathan Wellum. As a value investor, AIC tends to be light on resources. The company has put a lot of emphasis on processes during the past five years and has rebranded itself as a leading value investor.

AIC has also added three people on the investment-management side and plans to hire a couple more over the next few months. Wellum says 60% of AIC’s funds have net sales, largely in global and bond funds, but the big trademark Advantage funds are still in net redemptions.

Energy was a problem for AIM Funds, whose Trimark arm is another value investor. “This happens every now and then,” says Patrick Farmer, chief investment officer for Trimark, who points out that it was the performance of the funds during the tech boom in the late 1990s, during which they were also laggards, that prompted the sale of Trimark to Amvescap PLC. IE