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Morningstar columnist Don Phillips sees the failures of active fund manager performance as a function of the number of investors who have given up on stock picking.

Every trade has a buyer and seller, which means market returns are a zero sum game – for every winner there must be a loser. As the average investor gets smarter, there is less ‘dumb money’ for active managers to pick off. Mr. Phillips believes that active managers have actually gotten better over time; there are just fewer winning trades available.

The author’s essay “No Failure Like Success” provides a valuable history lesson. In the 1980s, “active managers assumed, with some accuracy, that a large pool of uninformed individual investors underperformed the market, thus allowing the bulk of professional investors to better the averages." These were the glory days for fund managers.

Investors then moved into mutual funds but the assets hit the industry so quickly and indiscriminately that talented fund managers were able to take advantage of their less skilled counterparts. A more challenging environment for the pros, but still profitable for many.

We have now reached a point where the new benchmarks themselves provide more competition for active managers. Mr. Phillips notes that early indexes like the Dow Jones Industrial Average were designed for ease of calculation by journalists. Now, specialists with PhDs in finance design the indexes which implies that “benchmarks are now arguably as smart as the pros.”

The current trend towards passive investing points to eventual obsolescence for equity analysts and active managers, although that’s still hard to envision. Index-based investing has been a huge boon for investors but it’s a massive change in market structure that will eventually cause problems of its own.

Perhaps the most interesting part of the column was an aside regarding the ‘odd lots’ theory. This interprets equity trades of less than 100 shares as individual investor speculation, and the more odd lot trades, the closer we are to a market top.

-- Scott Barlow, Globe and Mail market strategist

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The Rundown

Canadian renewable energy stocks a boon for investors in 2019

Investors who embrace Canadian renewable energy stocks for the good of the planet have been rewarded this year with a pleasant side benefit: The stocks have soared, delivering gains that mock the fossil fuel-clinging political leadership in Washington. The share price of Northland Power Inc., which operates wind farms and solar facilities in Canada and Europe, has risen 27 per cent this year. Algonquin Power & Utilities Corp., which owns wind, solar and hydroelectric generating facilities in Canada and the United States, is up 34 per cent. And Brookfield Renewable Partners LP, which invests globally in hydro, wind and solar assets, is up nearly 72 per cent. Where does the hot renewable energy sector go from here? David Berman takes a look.

This little-known ETF may be the key to unlocking big gains ahead in British stocks

A key benchmark of British stocks surged to a record high on Friday, following a massive electoral victory by Boris Johnson’s Conservatives. Patient investors may want to bet on more stock gains to come. Ian McGugan explains why.

S&P/TSX Composite Index to add five companies, remove two

Canada’s major stock index will add five companies, but remove two, next week as it performs a quarterly rebalancing. David Milstead reports.

Others (for subscribers)

Monday’s analyst upgrades and downgrades

Others (for everyone)

Canaccord Genuity’s top Canadian stock picks for 2020

Globe Advisor

Why shifting the assets from tax-loss selling into a TFSA or RRSP makes sense

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Ask Globe Investor

Question: I have a wealthy friend who has recently taken investing courses so she can make her own decisions. She has learned about put and call options and other topics I know nothing about. In anticipation of an impending market implosion in 2020, forecast by every financial professional it seems, she intends to sell all her holdings and be completely in cash by the end of 2019. She will then reinvest a year or two later when the market stabilizes and begins its long climb back. I’m wondering if I should take more or less the same approach. I am a single woman, age 82 and a renter. I have about 80 per cent of my money in solid, dividend-paying stocks and 20 per cent in bonds. Would it be wise to ask my broker to put a 5-per-cent stop loss on my holdings so that if there is a decline beyond that, I will end up completely in cash?

Answer: Before I answer your question, let me ask you one: What if your friend is wrong and the market doesn’t collapse? She’s going to be kicking herself. Apart from missing out on the market’s future gains, she’ll lose the dividend income from the stocks she sold.

The truth is that your friend doesn’t know what the market will do next year. Nobody does. But on any given day there will always be someone predicting a market collapse and someone else calling for the market to soar.

But let’s say she’s right and the market plunges in 2020. By going into cash now she’ll avoid losses in the short run. But getting back in might be a lot harder than it sounds. Bear markets are usually accompanied by scary headlines, dire economic warnings and pervasive fear. Maybe your friend has nerves of steel, but it’s possible that she will be too freaked out to reinvest any of her cash. Or she might wait until investor sentiment has turned positive, by which time the market will have already recovered.

As for stop-loss orders, I’m not a fan. When you enter a stop-loss order, you’re telling your broker to sell your shares if they fall to a certain price. But all this does is lock in your loss; if the shares subsequently recover, you’ll be left behind. You mentioned that your equity holdings are all “solid, dividend-paying stocks." If the businesses are sound, selling just because the shares have dropped in price doesn’t strike me as a prudent strategy.

Nor do I see any reason for you to use put and call options or other exotic tools. These products have a place in sophisticated trading strategies, but for most small investors I believe that a simple buy-and-hold approach is best.

If you’re concerned about losing a chunk of your capital in a downturn, my advice would be to review your portfolio to make sure that you are diversified across sectors and hold only high-quality companies with a history of raising their dividends. (For examples, see my model Yield Hog Dividend Growth Portfolio.

If you are uncomfortable having 80 per cent of your assets in stocks, you may wish to dial back your equity exposure and put a portion of those funds into a high-interest savings account, guaranteed investment certificates or bonds. But going completely into cash, as your friend is doing, strikes me as a risky strategy that could backfire. I also recommend that you discuss these issues with your adviser.

--John Heinzl

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What’s up in the days ahead

Jennifer Dowty interviews BlackRock’s chief investment strategist for Canada to see what his predictions are for 2020.

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Compiled by Globe Investor Staff