How well are mutual fund investors doing in Canada? This question is not as simple as it may seem.
The Standard & Poor’s indices and active values (SPIVA) reports are useful for determining the percentage of active funds that have outperformed their benchmarks. For example, the most recent one found that just 2.5% of actively managed Canadian stock funds outperformed the S&P/TSX Composite Index in the five years ending 2010.
However, SPIVA reports have some limitations: most importantly, they do not report this degree this poor performance. Actually, as critics have noted, virtually all ETFs also fall short of benchmarks, so they would all be on the SPIVA report’s list of losers. The key point, of course, is this iShares S&P/TSX Capted Composite (XIC) last year it lagged the benchmark by just 22 basis points, while Investors Canadian equity fund—to name just one, more expensive alternative—he overtook it by 4.54%. Of course this is an important distinction.
I wish you the Morning Star
Justin Bender, Portfolio Manager at The capital of PWL in Toronto, recently provided me with more useful data on the fund’s performance. The Morningstar Fund Indexes bill themselves as “the best available reflection of the performance of aggregate dollars actually invested currently and historically in Canadian mutual funds and segregated funds.”
Morningstar indexes are asset-weighted, which means larger funds have more influence than smaller funds. This is also a more meaningful comparison than a simple average for all funds. For example, in the Canadian Equity category, we find that Canadian fund investors achieved a total return of -10.42% in 2011 compared to the index return of -8.71%. This is a result worse than 1.71%, which is very close to the 10-year average.
Fighting the couch potato
To get an idea of how a diversified portfolio of active funds would have performed over the past year, I created a chart using the Morningstar Indexes, which represent the asset allocation in A complete couch potato. The table below shows these funds’ composite MERs and investor returns in 2011:
| Category index | MAYOR | Return | |
| Canadian capital Morningstar | 20% | 1.50% | -10.42% |
| Morningstar American capital | 15% | 2.05% | -0.67% |
| Morningstar International Capital | 11.25% | 2.00% | -12.15% |
| Morningstar Emerging Markets Stocks | 3.75% | 2.61% | -19.63% |
| Morningstar Capital Real Estate | 10% | 1.57% | 12.67% |
| Morningstar Cdn Inflation protected fixed income | 10% | 1.31% | 14.87% |
| Morningstar Canadian Fixed Income | thirty% | 1.42% | 7.43% |
| 1.64% | 0.70% | ||
Now let’s compare these results to Complete Couch Potato’s ETFs in 2011:
| Exchange-listed fund | MAYOR | Return | |
| iShares S&P/TSX Capted Composite (XIC) | 20% | 0.26% | -8.93% |
| Vanguard Total Exchange (VTI) | 15% | 0.07% | 3.22% |
| Vanguard Total International Stocks (VXUS) | 15% | 0.15% | -15.45% |
| BMO Equal Weight REIT (ZRE) | 10% | 0.62% | 13.85% |
| iShares DEX Real Return Bond (XRB) | 10% | 0.39% | 17.87% |
| iShares DEX Universe Bond (XBB) | thirty% | 0.33% | 9.38% |
| 0.29% | 2.36% | ||
As you can see, the average dollar invested in actively managed funds underperformed comparable ETFs in every asset class in 2011. The biggest difference with US stocks comes from the fact that most Canadian mutual funds use currency hedges, while Vanguard Total Exchange (VTI) NO. Otherwise, poor performance can largely be explained by higher costs and poor timing.
But here’s where things get interesting. Investment fund companies, quite reasonably, they claim that some of these MERs pay for ongoing financial advice, so it’s not necessarily fair to compare them to a DIY ETF portfolio. They also claim – again, with good reason – that trading commissions apply to ETFs, not mutual funds.
However, it should be noted that the performance difference between the active funds and Complete Couch Potato was 166 basis points (2.36% minus 0.70%). So a paid advisor who uses passive ETFs and charges another 1% to 1.5% for advice and who incurs another 10 basis points in transaction costs would still outperform the typical mutual fund investor. As for Canadians who pay more than the total cost of 1.64%, well, they need to start asking some questions.
The data is clear. The industry can always point to individual stars, and investors can hope that their fund manager will be one of the winners. But as Nobel Prize winner William Sharpe argued over 20 years ago: the average actively managed dollar is bound to underperform dollar average managed passively at cost. Canadian fund investors proved in 2011 that the math has not changed.
