Andrew Hallam is the index investor for Strategy Lab. Globe Unlimited subscribers can view his model portfolio here and read more in the series online here.
When the stock market slides, active fund managers earn their fees. It's a trader's market when stocks go sideways. At least, that's the common sales spiel. It does sound convincing. But real world tests says the rhetoric is bogus.
It's comforting to think active managers may be able to forecast the market's direction. It would be nice if they could sell stocks before they slide and buy them back before they rise. But the tooth fairy's story is a lot more convincing. At least she leaves a bonus under the pillow at night. Active fund managers, by comparison, cost Canadians more than 2 per cent a year.
That might sound like a small price to pay. But it isn't. If the markets earn 4 per cent in a given year, investors paying 2 per cent may be giving up half of their profits to fees. That's money gone for nothing.
Every six months, the SPIVA Canada Scorecard compares Canadian actively managed funds with their benchmark indexes. The active funds almost always disappoint. Costs are heavy anchors. So even when stocks fall, managed funds can add further pain.
Take the 12-month period ending June 30. The S&P/TSX composite index dropped 1.16 per cent. But more than 60 per cent of Canadian active equity funds did even worse.
Nor was there respite for the Canadians who invested in actively managed U.S. funds. Over the 12-month period, the S&P 500 index beat 83 per cent of them. Results weren't any better for Canada's active global equity funds. The S&P developed large-/mid-cap index benchmark beat 82 per cent of that category's active funds.
Blended portfolio results were uglier still. According to Morningstar, the Canadian Focused Equity category is made up of funds that hold between 50 per cent and 90 per cent of their assets in Canadian stocks. Compared with a benchmark comprising 50 per cent of its assets in the S&P/TSX composite, 25 per cent in the S&P 500 and 25 per cent to the S&P EPAC large-/mid-cap index, the active funds suffered. The benchmark beat 90.16 per cent of the category's funds over the 12-month period.
Just one of five categories saw active managers win. Almost 73 per cent of Canadian small-/mid-cap funds beat the S&P/TSX completion index. When measured over the past five years, however, higher fees left their mark. Less than 43 per cent of the category's active fund managers beat their benchmark index.
High fund fees, after all, hurt more over time. It's like strapping a 20-pound sack of coal to your back, then challenging your neighbour to a 50-metre race. If you're fitter and faster, you still might win. But try that trick over 20 or 30 kilometres. Odds are you'll lose.
Over the past five years, the S&P/TSX composite index beat 77 per cent of active Canadian equity funds. Results were worse with U.S. equities. The S&P 500 beat almost 97 per cent of Canada's active U.S. stock market funds.
In the Canadian Dividend and Income Equity category, active managers were humiliated further. The Canadian dividend aristocrats index beat nearly 98 per cent of the category's active fund managers. Results were nearly as bad for active global equity managers. More than 95 per cent of them lost to the S&P developed large-/mid-cap index.
Most Canadians get talked into buying actively managed funds because they're profitable for banks and financial advisers. But such funds are usually a losing proposition. Sure, some of them beat the market. But without a working crystal ball, you won't see those winning funds before they triumph. Nor will your adviser. Don't believe me? Here's a great trick. If an adviser shows you a collection of market-beating funds, ask one question. "Can you prove that you owned these funds, five or 10 years ago?" That's how to call a salesperson's bluff.
Don't run with that 20-pound sack on your back. Build a portfolio of low-cost index funds. Costs are lower and performances are better.