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.
At the 1988 U.S. Open Tennis Championships, Jimmy Connors faced a young upstart named Andre Agassi. Connors had a legacy. At one point, a fan yelled, "Come on Jimmy, he's a punk, you're a legend!" But Mr. Agassi won.
The world of investing also has its legends. One famous firm is Phillips Hager & North. It was awarded the Best Overall Fund Group in Canada by the Thomson Reuters Lipper Fund Awards in 2010 and '11.
How did it do it? It served low-cost mutual funds. The typical actively managed equity fund in Canada costs about 2.3 per cent a year. Phillips Hager & North charges half that much. The PH&N Canadian Equity Fund, for example, has a management expense ratio (MER) of just 1.15 per cent a year. PH&N's U.S. Dividend Income Fund costs 1.17 per cent.
Morningstar's Russell Kinnell says that mutual-fund fees are the best predictors of future performance. The lower, the better. That's why index funds are popular. They're cheap. Over an investment lifetime, they serve aces to most active funds. But what if the cost of an active mutual fund were as low as an index fund? If the manager were skilled, that fund should win. At least, that's the theory.
Phillips Hager & North offers actively managed blended portfolios. Many comprise Canadian, U.S. and international stocks in addition to bonds. I looked at such funds with at least three-year track records. Those with higher stock allocations beat those with high bond allocations. That makes sense. Over time, stocks beat bonds.
Enter Tangerine. It also offers blended portfolios. But unlike the managers at PH&N, nobody at Tangerine tries to pick winning stocks. Nor does it tweak its funds to favour geographic sectors. The firm simply blends index funds. It ignores market forecasts and rebalances once a year.
I put each firm's funds in one of three different draws, based on similar stock and bond allocations. For example, PH&N's BonaVista Global Balanced Fund comprises 32 per cent bonds and cash, with the remainder split between Canadian, U.S. and international stocks. I compared it with Tangerine's Balanced Portfolio. It has 40 per cent in bonds, with the rest split between Canadian, U.S. and international stocks.
I put Phillips Hager & North toe-to-toe with Tangerine in a five-set match. In the first set, I compared funds with 25 per cent to 30 per cent in bonds and cash. Each company had only one fund in the category. Neither boasted a five-year track record, so I looked at three-year returns. Their expense ratios were similar: 1.25 per cent for the PH&N 2045 Lifetime Fund versus 1.07 per cent for Tangerine's Equity Growth Portfolio.
Tangerine took the first set with a 9.96-per-cent annual return during the three years ended April 30, 2016. Phillips Hager & North's contender gained 9.5 per cent a year.
For the second set, I compared funds with 30 per cent to 40 per cent in bonds and cash. Phillips Hager & North had four players. Their average three-year returns, ended April 30, 2016, was 8.38 per cent. Tangerine's Balanced Portfolio was its firm's only player. It also had the highest bond allocation. It makes up 40 per cent of the fund's total value. It posted an average annual return of 7.63 per cent. Phillips Hager & North took the second set.
In the third set, I compared five-year returns for the same funds. Tangerine's fund averaged 6.74 per cent a year. PH&N averaged 6.0 per cent. If this were a best-of-five Grand Slam match, Tangerine would now be up two sets to one.
Entering the fourth set, I looked at funds with 40 per cent to 50 per cent in bonds or cash. PH&N has three players with three-year track records. They won the set to tie the match, with one set remaining. PH&N's funds averaged 8.33 per cent. That beat Tangerine's Balanced Portfolio. It averaged 7.63 per cent over the same three-year period.
Tangerine, however, finished in style. Its Balanced Portfolio Fund averaged 6.74 per cent over the five-year period. PH&N's Balanced Fund (the firm's only contender with a five-year track record) managed just 6.2 per cent. Tangerine takes the fifth set and the match.
But the test was close. Categorized into slightly different groupings of stocks and bonds, it's entirely possible Phillips Hager & North might have eked out a win. It is, after all, a legend. Two years in a row, Lipper awarded it Canada's Best Overall Fund Group. But we shouldn't underestimate Tangerine's index funds.
They look a lot like Andre Agassi. And Mr. Agassi did, after all, beat Mr. Connors.