Every credible research study ever done on the topic concludes that investors will generate better long-term performance with an indexing strategy. That remains the case, but a recently published report by Goldman Sachs shows that the issue is more complicated.
The chart, posted here on social media, shows that the relative performance of active versus passive management is cyclical, and there are significant periods of time when active management outperforms the index after fees are calculated. Between 2000 and 2009, for instance, the median large cap U.S. equity fund outperformed the S&P 500 by an average of 1.9 per cent per year. This is significant, as an investment of $100,000 on Dec. 31, 1999 in the median fund would have outperformed the benchmark by a cumulative $22,000 to the end of 2009.
Goldman Sachs calculates that the reverse trend was apparent from 2010 to 2016 as active fund managers underperformed by an average of 1.2 per cent.
At some point in the next three years, the median actively managed fund is likely to begin another period of outperforming the index. (There is a big caveat in practical terms as investors will have to pick a fund that performs at least as well as the median fund in order to benefit from this, which is not an easy task.) Eventually, passive investors will be tempted to sell their low-cost index funds and move the assets into outperforming active funds.
The majority of investors should resist this temptation. For one, the Goldman Sachs research uses U.S. data and the same study is not available for domestic funds. History also strongly suggests that a trend of active outperformance will only be recognized when it’s well underway, and investors that make the switch are more likely to get caught when the trend inevitably reverses again.
It is important to recognize the cyclical relationship between active and passive investing strategies in order to keep portfolio returns in context and realize that in markets nothing, not even the proven, obvious benefits of low-fee indexing, works all the time.
-- Scott Barlow
This is the Globe Investor newsletter. If someone has forwarded this e-mail newsletter to you, you can sign up for Globe Investor and all Globe newsletters here.
Stocks to ponder
Atlantic Gold Corp. This is a top performing stock in the gold sector, rising over 52 per cent so far this year. All seven analysts who cover the company have buy recommendations on the stock, and the consensus target price suggests 26 per cent upside potential for the share price over the next year, writes Jennifer Dowty. The company has a near-term catalyst that may expand its valuation – gold production is anticipated to begin later this year. Furthermore, investors do not have to worry about geopolitical risks as its operations are located in Nova Scotia.
National Bank of Canada. This stock has delivered some bad news over the past 18 months: It has diluted investors by issuing new shares, taken an embarrassing writeoff on an investment and rattled observers with its large exposure to the troubled energy sector, writes David Berman. But the stock has soared. Since Oct. 1, 2015, when the lender issued the first of its trio of disappointments, National Bank’s share price has risen about 38 per cent (including dividends). This total return has beaten the broad S&P/TSX composite index by more than 13 percentage points.
Cannabix Technologies Inc. Vancouver-based Cannabix, a penny stock that trades on the Canadian Securities Exchange, claims to be the only Canadian publicly listed company with a breathalyzer prototype that aims to detect THC, or tetrahydrocannabinol, a substance that gives marijuana its intoxicating effect, writes Brenda Bouw. is hoping to capitalize on Ottawa’s plans to crack down on drivers impaired by marijuana with the development of a roadside breathalyzer that would detect traces of the drug.
Pretium Resources Inc. This top performing mid-cap gold stock has operations in Western Canada, and has eight buy calls and a 26-per-cent upside forecast, writes Jennifer Dowty. Vancouver-based Pretium continues to advance its operations towards its goal of full production at its high-grade underground gold project, its Brucejack Mine, located in northern British Columbia.
SIR Royalty Income Fund. This income fund has an attractive yield of 7.7 per cent. The unit price has increased 4.6 per cent so far in 2017, and rallied 10 per cent in 2016. With a market capitalization of $124-million, the fund is below the $200-million market cap screening threshold and as a result has never appeared on the breakouts list, writes Jennifer Dowty. Ontario-based SIR (Service Inspired Restaurants) Corporation owns a portfolio of 60 restaurants located primarily in Ontario under the banners Jack Astor’s Bar and Grill, Alice Fazooli’s, Scaddabush Italian Kitchen & Bar, Canyon Creek, Reds Wine Tavern, Reds Midtown Tavern, and The Loose Moose.
Markets show rising anxiety amid global tensions
Major stock market indexes are struggling for direction and typical haven investments are on the rise, suggesting investors are giving the market-driving optimism that greeted 2017 a long, hard look, writes David Berman. The S&P 500 has been zigzagging for the past six weeks while U.S. Treasury yields are well off their recent highs and gold is among the world’s hottest commodities – all of which points to an uptick in anxiety. It has many sources.
David Rosenberg: Are U.S. stocks overextended? Five factors investors must consider
Are U.S. equities overextended? Well, the first issue that must be addressed is: What exactly constitutes an overextended market to begin with? There are so many ingredients to take into account, writes David Rosenberg. Here they are, all five of them – you be the judge:1. Valuation (overly high pricing relative to underlying fundamentals); 2. Sentiment (too much optimism); 3. Ownership (concentration of assets); 4. Leverage (overreliance on margin debt); 5. An entrenched belief system (that prices can’t go down).
Are investors really poor market timers?
Norman Rothery looks at a number of different studies that examine whether investors are bad market timers. He concludes that while there are caveats and complexities that apply around the edges of the argument, the evidence doesn’t support the bad-timing accusation when it comes to stock investors in general. It applies only to particular individuals and sub-groups. Even then there is hope for bad timers who can reform their ways over time.
As Canadian stocks tread water, investors await profit rebound
Key Canadian companies are set to roll out their quarterly financial results over the next couple of weeks amid upbeat economic expectations and near-record-high stock prices, writes David Berman. Canadian Pacific Railway Ltd. and Rogers Communications Inc. are two highlights for this week. Barrick Gold Corp., Canadian National Railway Co., Metro Inc., Fairfax Financial Holdings Ltd. and Bombardier Inc. follow next week. These companies are among more than a dozen corporate heavyweights that should provide a clearer picture of where profits – and share prices – are headed.
If you can’t find a good fund manager, turn to ETFs
Warren Buffett, the billionaire famous for selecting stocks that become winning investments, has long said investors would be better off ditching high-fee actively managed funds and putting their money in low-cost indexing strategies, writes John Reese. That is because active managers often go through droughts during which they lag the market. Mr. Buffett wrote about this in his recent annual shareholder letter, repeating advice he gave shareholders in 2005, when he said professional investors – over a period of years – will underperform the returns achieved by amateurs doing nothing more than putting their money in an index fund. And then the higher fees also eat into any gains.
The best stock-picking strategy starts with this
Finance author Tim Richards is recommending a checklist-based stock-picking strategy for investors, and the more Scott Barlow thinks about it, the better the idea becomes. Not only does a checklist promote discipline and careful analysis, it also helps avoid dumb mistakes, which could be the most important skill in investing. Berkshire Hathaway’s Charlie Munger once noted “It is remarkable how much long-term advantage people like us have gotten by trying to be consistently not stupid, instead of trying to be very intelligent.”
Funds that bought in to Valeant – and lost
The remarkable collapse of the shares of Valeant Pharmaceuticals International Inc. didn’t just harm investors who chose to buy directly into the stock. Because of its brief honour of being the most valuable company in the S&P/TSX 60, Valeant shares found their way into dozens of Canadian mutual and exchange-traded funds, in many cases taking up an ample proportion of the portfolio, writes David Milstead. In some cases, there was little choice, as funds designed to mimic the performance of the index had to own Valeant’s stock. Plenty of other fund managers, however, proactively chose to own Valeant shares. And even as some began to sell as the shares slid from the August, 2015, peak, other funds, which previously avoided the expensive growth story, came to buy in, seeing it as a value play. Nearly all got burned, now that Valeant trades for about $12.50, down from its all-time high of nearly $350.
Sorry Mr. Trump, you can't make America great again and have a weak dollar
Donald Trump is discovering an awkward truth: When it comes to waging currency wars, it is awfully hard not to shoot yourself in the foot, writes Ian McGugan. The U.S. President rocketed to power by thundering that China is a currency manipulator and declaring that Federal Reserve chair Janet Yellen should be “ashamed” of herself for keeping rates artificially low to boost the economy and the Obama administration. This week, Mr. Trump executed U-turns on all those positions. China, it turns out, is not a currency manipulator after all. Low rates are just dandy. And Ms. Yellen? Gosh, she’s actually a fine person who just might be reappointed to her job, he told the Wall Street Journal. His comment that the U.S. dollar is “getting too strong” sent waves rippling through currency markets as traders tried to figure out what the comment portended. Could Mr. Trump be signalling a major shift in the strong-dollar policy that has ruled Washington since the mid-1990s? Could he be mulling a new international pact designed to weaken the greenback? Could he be signalling a new currency war? Maybe. But he could just be displaying, once again, his lack of economic polish.
Here's why the loonie's most recent rally should be short lived
Bond markets and crude prices continue their tug-of-war for control of the loonie with bond yields continuing to hold a small advantage, writes Scott Barlow. The Canadian dollar climbed almost half a cent early Wednesday after the Bank of Canada noted stronger than expected economic data, but longer term trends suggest that strength in the loonie could be short-lived.
Why Canada's equity investors may want to step up emerging-markets exposure
Canada and the developing world have grown apart, writes Tim Shufelt. Once so aligned as to be virtually indistinguishable, Canadian and emerging-market equities now look very different from one another. The rise of technology and consumer sectors have made stocks in developing countries far less dependent on commodity prices – the kind of evolution that still eludes the Canadian stock market.
Three stocks I'm betting on that will prove my case against index investors
One of the 10 commandments of investing, is surely, “Thou shalt diversify.” This mantra is taught in finance departments in the country’s finest universities and has become an unquestioned principle in the world of financial planning where it has been widely practised, writes Larry Sarbit. Concentration can be a double-edged sword. A large, bad investment can destroy capital while the well-thought-through, well-researched equity purchased at a reasonable or cheap price has a higher probability of producing outsized rates of return over the long term. He outlines three stocks his company focuses on: Berkshire Hathaway, Sirius XM Holdings Inc., and Lions Gate Entertainment Corp.
Do I buy a bank ETF or individual bank stocks?
Bank stock quandary: Try to pick the best banks, or just buy them all, writes Rob Carrick. A reader asked this question recently. He wanted to know the pros and cons of buying individual bank stocks versus a Canadian bank ETF. Let’s dig into this using the BMO S&P/TSX Equal Weight Banks Index ETF (ZEB-T) and the shares of each of the Big Six bank. He explores the the pros and cons of either choice.
Love bank stocks? The pros do, too
You’re in good company if you’re a dividend investor with a portfolio dominated by bank stocks, writes Rob Carrick. Managers of a lot of the top-performing dividend mutual funds do the exact same thing. In quite a few cases, banks dominate the top holdings in these funds and financial stocks as a sector account for more than half the portfolio. These observations are based on some analysis done using Globeinvestor’s mutual fund database. We start with nine of the best performers over the five years to March 31. For each, portfolio details were examined using Globeinvestor’s fund profiles.
Gordon Pape: Here’s how to take advantage of the REIT rebound
Four months ago, REITs were being written off by investors as losers in the Donald Trump world of economic stimulus and higher inflation, writes Gordon Pape. The S&P/TSX Capped REIT Index had plunged from over 170 in the summer of 2016 to the 145 range shortly after Mr. Trump’s election. REITs are interest-sensitive securities and investors were betting they’d be hit hard in the new economic order the President was envisioning. As it turned out, Mr. Trump has run into some major roadblocks in the implementation of his policies. This has prompted investors to revisit their assumptions about REITs and other interest-sensitive securities. The REIT Index has rebounded strongly, closing last week at 164.
Gordon Pape: These ETFs will help you play the new rising star of Asia
A few years ago, everyone wanted to put money into China. The country’s GDP growth was the envy of the Western world, the rapid expansion of the middle class was fuelling demand for consumer goods, and stocks were booming, writes Gordon Pape. That was then. Today, China has fallen out of favour with investors. Economic growth is faltering, business failures are on the rise, and the country faces the potential of a damaging trade war with the United States. Money is still flowing in, of course – you can’t ignore the world’s most populous country. But investors are more cautious and expectations muted compared with a few years ago. The new rising star in Asia is India.
I’m saving for a house. Should I invest my money?
Whether you’re saving for a house, a university education or any other large expenditure, the general rule of thumb is that you shouldn’t invest money if you’ll need to spend it in the next five years. In such circumstances, the priority should be keeping your principal safe, writes John Heinzl. The rationale is simple: Over the long term, the stock market has produced annualized total returns in the high single digits, which is why stocks are your best bet if you plan to put your money away for many years.
Value investor seeks good management, widely used products
Peter Scourtoudis was dealt some blows when he invested in the stock market just before the crash in 2008-09. But that made him determined to become a better investor. So he looks for undervalued companies that have good management and widely used products, writes Larry MacDonald in this week's Me and My Money profile.
Ask Globe Investor
Do you have a question for Globe Investor? Send it our way via this form. Questions and answers will be edited for length.
What’s up in the days ahead
Watch for David Milstead's take on Constellation Software; John Heinzl will explain why he's buying more TransCanada stock; Ian McGugan is writing about Manulife Financial Corp.'s launch of four exchange-traded funds (ETFs) designed by the high-powered intellects at the Texas firm Dimensional Fund Advisors; and Gordon Pape is writing about the rebound in REITs.
More Globe Investor coverage
For more Globe Investor stories, follow us on Twitter @globeinvestor
Click here share your view of our newsletter and give us your suggestions.
Compiled by Gillian LivingstonReport Typo/Error
Follow us on Twitter: