A question to the two sides in the investing world's never-ending war over index investing: Can't we all just get along?
Surely there must be some common ground between indexers, who believe the best investing approach is to buy funds that let you make the same returns as major benchmark stock indexes, and adherents of active management, who believe you're better off in the hands of a professional fund manager who chooses individual stocks and bonds.
Each side claims to be the one true path to an ideal investment portfolio, which means they're perpetually trying to discredit the other. On and on, they fight in a war of statistics that can never be won definitively.
So maybe it's truce time. Indexers and active management types, let's join forces and see what develops.
If you think about it, indexing and active management can be mutually reinforcing, not mutually exclusive. Indexing means you'll make the return of any number of major stock indexes through ownership of an index mutual fund or exchange-traded fund, which trades like a stock. Active management is the technical term for what mutual fund managers do in selecting their own stock holdings, rather than passively mirroring an index.
Believers in active management argue that a smart manager can deke around stock market upsets, thereby smoothing out the volatility you'd get in an index fund and delivering higher overall returns. But even if we assume that lots of fund managers can do this, there's still a problem. When a major stock index really takes off, many fund managers can't keep up.
Combining indexing and active management can give you the best of both strategies. When the stock markets are flying, your index funds will allow you to fully participate, and when the indexes are flat or falling your actively managed funds will have the opportunity to deliver.
The largest Canadian equity fund by far is Mackenzie Ivy Canadian, with about $5.3-billion in assets. This is a conservative fund that offers excellent medium-term numbers, uneven recent returns and a compelling argument for partnering active and passive management. Let's put Ivy Canadian together with an ETF that tracks the S&P/TSX composite index, the TD S&P/TSX Composite Index Fund.
Over the five years to April 30, Ivy Canadian was the place to be as it made a compound average annual return of 6.2 per cent. The TD exchange-traded fund hasn't been around for five years, but we can easily estimate its return by taking the gain of the underlying index and subtracting 0.3 of a percentage point to cover management fees and any errors by the ETF's managers in tracking the index. By this reckoning, the TD fund would have made just 1.4 per cent annually.
More recently, the TD fund has delivered one- and three-year returns of 15.3 per cent and 8.6 per cent, respectively, much better than Ivy Canadian's one-year gain of 10.6 per cent and its three-year return of 3.6 per cent.
Fans of active management might interject at this point and say the best approach would have been to hold Ivy Canadian for the past five years and not bother with an ETF. That's a reasonable argument from a numbers-only point of view, but introduce human emotion into the equation and all of a sudden ETFs look a lot more interesting.
Ivy Canadian's glory years in the past half decade came during the bear market, when it stood tall while the S&P/TSX composite was dragged down in large part by its huge exposure to Nortel Networks and other technology stocks. Then, when the markets rebounded in 2003, the TD ETF came into its own and bested Ivy Canadian.
