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The track record for the average mutual fund manager is terrible, and I’m not here to defend it. That said, there is a phenomenon currently underway that makes portfolio managers look worse than they really are.

In his Weekly Kickstart report, Goldman Sachs strategist David Kostin wrote, “The average large-cap mutual fund actually carries a 20 basis point underweight in [Facebook Inc.] stock.”

Since funds underweight in Facebook were more out of the way of the stock’s steep downdraft last week, a significant number of mutual funds were able to outperform their benchmarks.

This brief change in trend — Facebook has been a member of the FAANG (Facebook, Apple, Amazon, Netflix, Google) stocks that have been driving upside returns for U.S. markets — highlights a multi-year dilemma for portfolio managers whereby being prudent about portfolio risk results in underperformance of the benchmark during market rallies.

A manager that reasonably decides, for instance, to limit holdings in Amazon because of the stock’s price to earnings ratio of 180 times, will almost certainly underperform their benchmark if Amazon continues higher.

No one manages risk in an index by underweighting stocks with extremely high valuations. In the market capitalization weighted S&P 500 (a 1-per-cent price move in Facebook affects the index by 431 per cent more than a similar change in General Electric, for instance), the leading stocks drive upside returns until they break, and extreme levels of diversification are supposed to limit the down side.

Every credible study shows that passive, index-based investing strategies provide the best long-term performance. However, a market environment where the few stocks driving index returns break down puts index-based investors at a distinct disadvantage to the best active money managers.

In the late 1990s, investor assets became highly concentrated in technology and telecom stocks, driving valuation levels to (in hindsight) obscene levels. When the tech party ended, the slide downward in related stocks crushed index returns - the benchmark's inherent diversification failed to mitigate the performance damage to any significant degree.

Many fund managers that had trailed the benchmark through the late 1990s by holding reduced or zero weightings in Microsoft Corp., Cisco Systems Inc., Nortel Networks Corp. and other market favourites were able to outperform the benchmark in the early 2000s. Few investors noticed though, because they were watching the index plummet and had no interest in committing new funds to the market.

Mr. Kostin mentioned that the current U.S. market leadership is becoming concentrated: "The top 10 contributors have generated 62 per cent of the S&P 500 year-to-date return” so far this year, but that this narrowing market breadth has not yet reached late ’90s extremes.

Again, passive index investing is the best approach for most investors. But, if we're not quite in the danger zone in terms of market breadth, it's always best to prepare performance expectations long before we're forced to.

-- Scott Barlow, Globe and Mail market strategist

This is the Globe Investor newsletter, published three times each week. If someone has forwarded this e-mail newsletter to you, you can sign up for Globe Investor and all Globe newsletters here.

Stocks to ponder

Canadian tech stocks are feeling the FAANG (Facebook, Apple, Amazon, Netflix, Google) drop, writes Tim Shufelt. Investors are increasingly concerned about tech stocks ever since Facebook downgraded its growth expectations last week. Canada’s information technology sector has lost 10 per cent from recent highs, while some of the biggest Canadian IT listings, such as Constellation Software Inc. and Shopify Inc., have declined by 15 per cent or more over that time, Mr. Shufelt writes (for subscribers).

Gold Standard Ventures Corp. (GSV-T) is a small-cap stock that appears on the positive breakouts list, according to Jennifer Dowty. Gold Standard has a flagship project located in a prolific gold region in the U.S. and a very active, fully funded 2018 exploration program. Producers Goldcorp Inc. (G-T) and OceanaGold Corp. (OGC-T) also have significant ownership positions in the stock. “This stock is best suited for consideration by investors with a high risk tolerance given the share price volatility and company’s lack of earnings,” writes Ms. Dowty (for subscribers).

RioCan Real Estate Investment Trust (REI.UN-T) is scheduled to report its second-quarter financial results before the market opens on Aug. 8. Analysts are forecasting the REIT to report steadily improving operational results as it continues to execute on its disposition program. The trust has been active in its buyback program and increased its distribution earlier this year. Its current yield is an attractive 5.8 per cent and the consensus target price implies a potential one-year total return (including the yield) of over 14 per cent. Toronto-based RioCan owns and operates a portfolio of 284 retail and mixed-use properties across the country, including 17 properties that are under development. Jennifer Dowty reports (for subscribers).

An initial burst of enthusiasm for TransCanada Inc. and Enbridge Inc. shares has subsided as investors have digested a recent regulatory ruling from the U.S. As David Milstead reports, investors believe the ruling isn’t that bad. The U.S. Federal Energy Regulatory Commission (FERC) rattled pipeline investors in March when it said it would make rules prohibiting pipeline master limited partnerships (MLPs) from recovering corporate taxes when they set their regulated rates. That news sent the price of publicly traded MLP units spiralling downward and impacted the two Canadian giants because each has one or more U.S.-based MLPs. Mr. Milstead explains what has happened since, and the investor reaction (for subscribers.)

The Rundown

Why you might want to own ETFs in your portfolio

Too many investors are avoiding exchange-traded funds either because they don’t understand them, or believe they’re too risky. But as Gordon Pape writes, ETFs generate low-cost cash flow while providing much-needed portfolio diversification. While some ETFs are risky, and intended for market gamblers, there are many safe ETFs that provide the right balance between risk and return that most investors seek. Mr. Pape recommends four safe options for income-focused investors (for subscribers).

Horizon launches two ETFs to better compete with rivals

Horizons ETF Management (Canada) Inc. is introducing two ETFs that automatically rebalance and provide one-stop shopping to a portfolio of underlying equities and fixed income funds. The firm is taking direct aim at Vanguard Investments Canada Inc., which launched similar low-fee balanced ETF products earlier this year, Clare O’Hara writes. It also means another competitor for robo-advisers and their simple-solution, low-cost portfolios for investors.

How does your brokerage firm rank when it comes to parking cash? Online brokerages are flush with cash these days. According to a report from Strategic Insight, cash deposits combined with money sitting in investment savings accounts for about 15 per cent of total assets at online brokerages. The most popular option for holding cash is an investment saving account that you invest in the same way as you would a mutual fund, at no cost to buy or sell, according to the Globe’s personal finance columnist, Rob Carrick. “Investment savings accounts are what money market funds were before their fees started to overwhelm returns – the most practical way for the typical investor to park cash and earn at least a trace of interest,” he writes. But Mr. Carrick also suggests an exchange-traded fund that performs the same function. He also rates brokers on how to maximize returns on cash. See how your broker ranks in this list (for subscribers).

The potential pitfalls of cottage joint-ownership in the family

Thinking of putting your recreational property into a joint ownership agreement with the kids? Some families choose this option to avoid probate fees and facilitate a quick and easy transfer upon death. But it might not be the best solution, writes tax expert Tim Cestnick. Using the example of a family with a place in Ontario, Mr. Cestnick outlines three common problems that came come up with the joint-ownership arrangement.

Top Links (for subscribers)

Most accurate equity strategists of 2018 predict difficult second half for investors

‘A coming correction will be biggest since February' - Morgan Stanley

Others (for subscribers)

Monday’s analyst upgrades and downgrades

Monday’s Insider Report: Companies insiders are buying and selling

Tuesday’s analyst upgrades and downgrades

Tuesday’s Insider Report: Companies insiders are buying and selling

Others (for everyone)

Monday’s analyst upgrades and downgrades

Monday’s Insider Report: Companies insiders are buying and selling

Tuesday’s analyst upgrades and downgrades

Tuesday’s Insider Report: Companies insiders are buying and selling

Number Crunchers (for subscribers)

19 small-cap growth stocks and ADRs trading at a discount

Ask Globe Investor

Question: How long do I need to keep my tax records?

Answer: The Canada Revenue Agency recommends that you keep records for six years. The six-year period starts at the end of the tax year to which the records relate. For example, records for the 2017 tax year should be kept for six years starting from Dec. 31, 2017 - that is, until Dec. 31, 2023. In addition to expense receipts, keep your T4s and other T slips, receipts for charitable donations, cancelled cheques, bank records and any other documentation to back up deductions or credits you claimed. You’ll need this information should the CRA review your return. In the case of securities, real estate or other property that could generate a capital gain or loss, you’ll need to keep records of the original purchase and any subsequent investments that affect the adjusted cost base of the property during the time that you own it. These records will be required to calculate your capital gain or loss when you eventually sell the property. You should keep the records for six years after the year of the sale should the CRA ever question you about the gain or loss.

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Compiled by Brenda Bouw

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Tickers mentioned in this story

Study and track financial data on any traded entity: click to open the full quote page. Data updated as of 29/05/24 3:59pm EDT.

SymbolName% changeLast
ENB-T
Enbridge Inc
-0.81%48.93
OGC-T
Oceanagold Corp
-4.94%3.08
AAPL-Q
Apple Inc
+0.11%190.5
CSU-T
Constellation Software Inc
-0.51%3760.84
MSFT-Q
Microsoft Corp
-1.05%424.66
G-T
Augusta Gold Corp
-1.75%1.12
AMZN-Q
Amazon.com Inc
-0.24%181.59
SHOP-T
Shopify Inc
+0.79%80.04
CSCO-Q
Cisco Systems Inc
-0.26%45.96

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