Canadian mutual fund managers investing in U.S. stocks are almost universally failing to beat their benchmarks, further dragging down the reputation of active management.
Recent data show the vast majority of Canadian-based U.S. equity funds falling short of broad stock indexes, adding to evidence that Canadian investors should seek U.S. exposure through index funds or low-cost exchange-traded funds (ETFs).
“It pains me to say it, because I love the theory of active management,” said Dave Paterson, fund analyst at D.A. Paterson & Associates. “But there are so many funds that just don’t do what they’re supposed to do.”
Actively managed funds typically carry premium fees, presumably for the possibility of generating superior returns. In reality, however, research has generally shown active management to underperform the broader market, after accounting for fees.
In Canada, that underperformance is most stark when it comes to cross-border investing.
The most recent Standard & Poor’s SPIVA Canada Scorecard, released last month, shows mutual fund performance after all fees and costs, up to the end of June. In the Canadian equity category, 32 per cent of active funds beat the S&P/TSX composite total return index over the past three years. About 20 per cent beat the index over the past five years.
Those figures hardly inspire confidence, but are relatively stellar compared to the beat rate on U.S. equities. Over the past three years, about one in 70 funds beat the S&P 500 Total Return Index. Over the past five years, about one in 20 outperformed.
“It’s becoming increasingly difficult to find U.S. equity funds that I can recommend,” Mr. Paterson said.
By no means is that estimation of active management limited to Canada.
Only 18 per cent of actively managed U.S.-based large-cap equity funds are beating the market this year so far, up to the end of October, the worst performance in more than a decade, according to figures released by Bank of America.
“The U.S. has always stood out as the most striking example of where active management really struggles,” said Dan Hallett, vice-president and principal, HighView Financial Group.
The world’s most developed, most liquid, most efficient stock market has a way of thwarting most stock pickers, he said.
The few that do beat the benchmark tend to have substantial weightings in U.S. small and mid-cap stocks, where inefficiencies might be exploited, Mr. Hallett said. But U.S. stock gains so far this year have been led by the large-cap sector, with the S&P 500 index gaining 10.3 per cent, compared to just 1.0 per cent on the Russell 2000 small-cap index.
The resilience of the bull market itself has also skewed the odds against active management, which has always been sold as a way to mitigate losses in the event of a downturn.
That theory was undermined, however, by the financial crisis, which hit most actively managed U.S. funds just as hard, or harder, than the broader market. “There were only a handful of funds that did what they should have done,” Mr. Paterson said.
That memory still fresh, investors have responded by pulling money out of actively managed funds – $70-billion (U.S.) this year through September, according to Morningstar. That resumes a multiyear trend in favour of index funds, which was briefly interrupted in 2013.
“The obvious success of index tracking in all the asset classes is so transparent, it sinks in after a while,” said Terry Shaunessy, president and portfolio manager at Shaunessy Investment Counsel.
There are circumstances, however, that still call for an active approach, Mr. Shaunessy said. “When you start to step out to international small caps and emerging markets, you should have an active manager for that.”
But when it comes to Canadians looking to optimize their exposure to U.S. stocks, his advice is unequivocal: “Always choose passive ETFs listed in Canada.”Report Typo/Error