As at the end of 2017, Canadians still had 88.8% of their mutual fund and ETF
assets invested in actively managed products. In the US,
65% of mutual fund and ETF assets are invested in actively managed products.
This would all be fine if actively managed funds were delivering any semblance of decent
performance. Unfortunately, the performance of actively managed funds continues to be dismal.
I’m Ben Felix, Associate Portfolio Manager at PWL Capital. In this
episode of Common Sense Investing, I’m going to tell you just poorly
actively managed mutual funds in Canada have performed for the past ten years.
The SPIVA Canada report is a fascinating analysis prepared by Standard and Poors.semi-annually.
Recently they published their year-end report for 2017. For the first time
this report contains data going back ten years for all sections of the report. The
report compares the performance of actively managed mutual funds
in Canada to their relevant benchmarks, it addresses the issue of survivorship,
and it details the average performance of Canadian actively managed mutual funds.
For the the ten-year period ending December 2017, only eight point one four percent of Canadian
equity mutual funds in Canada outperformed the S&P/TSX composite index; twenty two point four
one percent of Canadian small-cap mutual funds outperformed the S&P/TSX Completion Index;
zero point zero zero percent of Canadian Dividend and Income Equity mutual funds outperformed the
S&P/TSX Dividend Aristocrats Index; one point six seven percent of US Equity funds outperformed the
S&P 500 Index in Canadian dollars; six point zero five percent of International equity mutual funds
outperformed the S&P EPAC LargeMidCap index in Canadian dollars; and two point four five percent
of global equity funds outperformed the S&P Developed LargeMidCap index in Canadian dollars.
Ouch. Those numbers are pretty bad. Of course, saying active funds don’t usually beat the
index is only half of the story. An index fund investor doesn’t get to invest in the
index without fees. After fees, 100% of index fund investors underperform the index. The
important nuance is that index investors should only underperform by the cost of
owning their index fund, which should be very small. We would expect actively managed funds,
on average, to underperform approximately by the amount of their fees. The average
equity mutual fund in Canada has a fee of around two point two percent.
Over the same 10-year period, Canadian equity funds underperformed the index,
on average, by zero point seven nine percent; Canadian small cap funds underperformed
by zero point two one percent; Canadian dividend and income funds underperformed
by two point six five percent; US equity funds underperformed by three point six two percent;
International equity funds underperformed by two point eight five percent;
and global equity funds underperformed by three point zero nine percent.
In most cases, the underperformance across the board is substantially higher than the
cost of owning index funds. Even if an index investor is paying one percent
on top of the cost of the index funds for advice to a fee based firm like PWL Capital,
they are still better off than the average active mutual fund investor by a large margin.
The question that follows these ugly performance numbers is why doesn’t it
seem this bad on the ground? Mutual fund companies and banks do not have rosters
of funds that have consistently trailed the index. They always have some funds with good
past performance to show off. The reason is survivorship bias. The consumer only gets to
see the funds that have survived. The funds that do poorly simply close and disappear.
Of the funds that existed on January first, 2008, only thirty seven point two one of Canadian equity
funds still existed On December 31, 2017. Forty six point five five percent of Canadian small cap
funds still existed; sixty two point five percent of Canadian dividend funds; fifty percent of US
equity funds; forty six point nine seven percent of International equity funds; and fifty point
three one percent of global equity funds. It’s probably safe to say that about 50% of the funds
at the start of the ten year period continued to exist at the end of the period. This is why it is
so hard for a consumer to believe that actively managed funds underperform so consistently.
What about the funds that still exist and beat their benchmark index? We don’t have
great data available for Canadian funds on that, but we can look to the US. S&P
also publishes a persistence scorecard for US actively managed mutual funds. Of the
585 top quartile performer domestic equity funds in the US that existed in March 2013,
only two funds, or zero point three four percent of top quartile funds,
were able to stay in the top quartile through December 2017. Interestingly, the data show that
it is more likely for the best performing funds to become the worst-performing funds than vice versa.
All of this corroborates Mark Carhartt’s 1997 paper On Persistence In Mutual Fund
Performance where he concluded that “The results do not support
the existence of skilled or informed mutual fund portfolio managers.” If
managers that do well are lucky rather than skilled, we would expect poor persistence.
If people who are financially independent and have more capital than they need to fund
their expenses want to take on the risk of owning actively managed funds for a
small chance at market beating returns. I see no problem with that. For the average
family saving up for retirement and other financial goals, I see little reason to take
on active risk when the probability of a positive outcome is so remote.
Do you still invest in actively managed mutual
funds? Please tell me what I’m missing in the comments.
Thanks for watching. My name is Ben Felix of PWL Capital and this is Common Sense
Investing. I’ll be talking about a lot more common sense investing topics in this series,
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