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.
I love Tangerine's mutual funds. They're cheap. They're simple. They're the bogeymen that taunt Canada's mutual fund industry. If they don't keep the industry up at night, they should.
Tangerine, an online bank owned by Bank of Nova Scotia, builds portfolios of indexes wrapped up into single funds. They offer three balanced funds: Balanced Income, Balanced and Balanced Growth. Each year, the company rebalances the indexes back to each fund's original allocation.
For example, Tangerine's Balanced Income Portfolio allocates 70 per cent to a Canadian bond index, with the remainder split between a Canadian, a U.S. and an international stock market index. If, at the end of the year, Canadian stocks report the biggest gain, Tangerine sells pieces of the Canadian index, adding the proceeds to the underperforming indexes.
Actively managed balanced funds have professional fund managers at their helms. They forecast the direction of specific stocks and they trade accordingly. They can also tweak their funds based on asset allocation forecasts. If they think bonds will beat stocks over a given year, they might tweak their funds to increase their bond market exposure.
This all sounds good in a marketing brochure or coming from the lips of a financial adviser, but academic studies prove otherwise. Most active funds underperform their benchmark indexes. Winning funds, historically, often slip to mediocrity.
RBC Global Asset Management, a division of Royal Bank of Canada, offers more than a dozen balanced or portfolio solution funds. They cost more than Tangerine's funds. So it's no surprise that they don't perform as well. But high costs aren't the only problem for RBC. Their fund management decisions sometimes make things even worse.
Tangerine's Balanced Income fund averaged 7.02 per cent over the past five years. Three of RBC's balanced funds compete with it. But Tangerine wins. RBC Select Very Conservative Portfolio contains about 80 per cent Canadian bonds, with the rest split into Canadian, U.S. and international stocks. Over the past five years, it averaged 5.4 per cent.
RBC Select Conservative Portfolio and the bank's RBC Select Choices Conservative Portfolio contain about 65 per cent Canadian bonds. The rest is split between Canadian and global stock market funds. Over the past five years, they averaged 6.9 per cent and 6.7 per cent, respectively.
Tangerine's Balanced Portfolio contains 40 per cent Canadian bonds, with the remainder once again split between Canadian and global stock market indexes. Over the past five years, it averaged 9.68 per cent. Five of RBC's balanced funds are similarly allocated. Their fixed income allocations are between 40 per cent and 45 per cent, with the remainder split between Canadian and global stocks.
These funds include:
- RBC Balanced Fund;
- RBC Global Balanced Fund;
- RBC Jantzi Balanced Fund,
- RBC Select Balanced Portfolio; and
- RBC Select Choices Balanced Portfolio.
None of them kept pace with Tangerine's Balanced Fund over the past five years. On average, the Tangerine fund beat them by 1.52 per cent per year.
RBC's balanced mutual funds cost an average of 2.2 per cent per year. Tangerine's Balanced Fund costs 1.07 per cent.
RBC's investors, however, can't blame their poor performance on high costs alone. Tangerine's Balanced Fund beat RBC's funds by an amount greater than the cost difference between the funds themselves.
That means RBC's trading didn't make things better. It made things worse.
Tangerine's Balanced Growth Portfolio takes on slightly more risk. It contains 25 per cent Canadian bonds, with the rest split evenly between Canadian and global stocks. It averaged 10.94 per cent over the past five years.
RBC Select Choices Growth Portfolio is similarly allocated. It averaged 10.2 per cent. Its MER is 2.36 per cent. RBC's fund managers did well, but they couldn't overcome their fund's higher fees.
RBC isn't a bad fund company. Their fund managers are smart. And their fund costs are similar to those of other actively managed balanced funds. But there's plenty they could learn from a bunch of Tangerines. RBC could, in fact, do something radical. It could convert their actively managed balanced funds into low-cost index fund portfolios. It would be great for investors.
But swallowing pride could be tougher than downing a whole tangerine.