More and more Canadians are moving their money out of traditional actively managed mutual
funds, and into low-cost index funds.
The market share of index funds in Canada has doubled since 2007, sitting at 11.3% at
the end of 2016.
That number may not mean much to you, but what that means is that of ALL of the mutual
fund and ETF investment assets in Canada, 11.3% of them are invested in index funds
or similar passively managed products.
Back in 2007, that number was only 5.6%, so the share of assets in passive investments
has doubled in 9 years.
This shift toward index funds is not happening by accident.
I’m Ben Felix, Associate Portfolio Manager at PWL Capital.
In this episode of Common Sense Investing, I’m going to tell you why individual investors
and large institutions are tossing their expensive actively managed funds, and buying low-cost
index funds.
Actively managed funds come with the attractive claim that they can beat the market – that’s
how active fund managers justify their higher fees.
It’s worth it to pay more if you’re getting more in return, right?
On the surface, this sounds pretty good.
Why wouldn’t you want a professional money manager with lots of knowledge and experience
making decisions about your money?
But here’s the problem with that theory: active management, on average, fails to deliver
on its promise of outperformance.
So now you are paying higher fees AND on average,
getting worse performance.
Not as attractive any longer.
In a 1991 paper, Nobel Prize winner, William Sharpe explained that it is mathematically
impossible for all active managers to outperform.
Together, they are all investing in the same market, so their average return must equal
the market return less their fees.
If one active manager is doing better than the market, it means that another one is doing
worse.
It’s a zero-sum game.
Adding to our understanding of how active management works, S&P Dow Jones Indices produces
a semi-annual report that compares the performance of Canadian mutual funds to their relevant
benchmarks.
Consistently, in every fund category, the average active fund tends to underperform
its benchmark over 1, 3, and 5 year periods.
The performance of actively managed mutual funds has been really bad for a long time,
and with the data at our fingertips, people are starting to notice.
Widely-read Canadian journalists like Dan Bortolotti of Money Sense and Rob Carrick
of the Globe and Mail have been spreading the message by writing about the issues of
high fees and poor performance for years.
Both of them suggest low-cost index funds as a solution.
But it’s not just journalists spreading the message.
You may have heard of a guy named Warren Buffett?
If you haven’t, he’s one of the most well-known and successful investors in history.
In his annual letter to shareholders, Buffett has a habit of taking shots at the active
fund management industry.
In his most recent letter, he wrote "When trillions of dollars are managed by Wall Streeters
charging high fees, it will usually be the managers who reap outsized profits,
not the clients.
Both large and small investors should stick with low-cost index funds."
Buffett has also put his money where his mouth is.
In 2008, he made a $1M bet that an S&P 500 index fund would beat a professionally selected
group of hedge funds over ten years.
With one-year left in the bet, Buffett is winning by a huge margin.
To top it off, CalPERS, the $300B California State pension fund, has been publicly shifting
assets out of actively managed strategies and hedge funds, and into low-cost index funds.
A 2013 TIME Magazine article titled The Triumph of Index Funds detailed CalPERS’ decisions.
The final push for Canadian investors might be new regulations that came into effect in 2017
Financial services firms are now required to disclose annually their clients’ performance,
and the fees that they have paid.
Fees have not always been transparent, and performance reporting has not been the standard.
With this information available, if the performance is bad and the fees are high, investors will
be looking for elsewhere.
Even with all of this attention on index funds, Canadian investors are still trailing far
behind Americans, where 34% of investment fund assets are in index funds and similar
passively managed products.
Join me in my next video as I explore why Canadians are so far behind on the move to index
funds.
My name is Ben Felix of PWL Capital and this is Common Sense Investing.
I’ll be talking about this and many other common sense investing topics in this series,
so subscribe and click the bell for updates.
I’d also love to hear from you as to what topics you’d like me to cover.