Skip to main content
strategy lab

Andrew Hallam is the index investor for Globe Investor's Strategy Lab. Follow his contributions here and view his model portfolio here.

Many Canadians flounder in actively managed mutual funds. According to the SPIVA Canada scorecard, 80.4 per cent of Canadian equity funds lost to the S&P/TSX composite index over the past five years. In the U.S. equity category, 94.9 per cent lagged the S&P 500.

I've compared fund company performances with retail indexes that you could buy instead. I examined Fidelity Canada, CIBC, RBC, Toronto-Dominion Bank, IA Clarington, Manulife and Trimark. In each case, I compared apples to apples. I examined 10-year fund returns, comparing them with retail indexes in the same asset classes. Most of the active funds fell on their faces.

Sure, we can blame high fees. According to Morningstar, Canadians pay the highest mutual-fund costs in the world. But could there be other reasons as well?

Harvard University professor Dan Ariely did an experiment. He paid two groups of people to build characters from Lego's Bionicles series. Each person earned money. The more they built, the more they earned. He wanted to see how determined they were. How long would each group keep going?

The first group had to watch each of their creations get disassembled before they could start building the next one. The second group didn't. Which group persisted to build more Bionicles, earning more money in the process? The second group did. The first group saw their hard work destroyed. So they weren't as motivated.

How does this relate to Canada's mutual fund industry? Imagine a mediocre year for stocks. The S&P/TSX composite gains 5 per cent. A hard-driving fund management team ekes out a 6.5-per-cent return. They should be thrilled. After all, their efforts beat the market by 1.5 per cent. But that's before they witness much of their work destroyed. The fund's expense ratio is 2.5 per cent. The firm takes this off the top. So the published results show the team earned just 4 per cent, instead of 6.5 per cent. If Prof. Ariely's theory holds true, many of Canada's fund managers could be demoralized.

Vijay Viswanathan says there could be other reasons for poor fund performances. He co-manages Mawer's Canadian Equity Fund, along with lead manager Jim Hall. Over the past 10 years, their fund has beaten the market. It averaged 10.6 per cent, compared with 7.9 per cent for the iShares S&P/TSX capped composite index. In fact, most of Mawer's funds have beaten their benchmark indexes.

Mr. Viswanathan says a boring investment philosophy and strong corporate culture are keys to success. Mawer's funds are also far cheaper than those of most Canadian fund companies. Its Canadian equity fund, for example, costs just 1.21 per cent. That's roughly half the industry average. Unlike most Canadian fund managers, Mr. Viswanathan doesn't have to see his work destroyed by fees.

Mr. Viswanathan points to studies published by author Daniel Pink. In his book Drive, The Surprising Truth About What Motivates Us, Mr. Pink says that high salaries and financial bonuses don't inspire people to excel when they're doing a job that requires a lot of brain power. So what does? Mr. Pink lists three things. Each of them, says Mr. Viswanathan, is part of Mawer's corporate culture: autonomy, mastery and purpose.

"We're given a lot of freedom to play to our strengths," he says. "It increases corporate morale since people can come to the office and do what they love doing every day."

Many accuse Canada's fund managers of following the index too closely when they buy stocks. When doing so, they create "closet index funds." On the outside, they look like actively managed products. But on the inside, they're like an index fund's twin. Not exactly the same, but pretty darn close. Investors may think they're paying for active management, but instead, they're buying a closet index that might charge as much as 2.5 per cent a year. Mr. Viswanathan says, "When it comes to investing we don't really care about the index. Plus you can't beat the index if you look like the index."

When scanning Mawer's Canadian Equity top holdings, you'll see some familiar names, such as TD Bank and Canadian National Railway. But some of the others may not be. Two out-of-the-box examples jump out. The fund has owned Constellation Software since August, 2009. Its stock has gained 834 per cent since then. They have also owned Saputo since September, 2005. Its stock has gained 261 per cent.

Will Mawer's funds continue to beat the market? That's hard to say. But with their low costs, high corporate morale and creative corporate culture, they stand a pretty good chance.