PETER DOLEZAL: Mutual fund scorecard for 2014

So why do so many Canadians continue to invest in mutual funds?

Sellers of mutual funds continue to promote their products to clients, proclaiming  that managed funds can outperform their comparable index benchmarks. Once again, the totally independent, annual SPIVA Canada Scorecard proves otherwise.

Their latest report on mutual fund performance for the year ending June 30, 2014 concluded that only 20.46% of managed Canadian equity funds outperformed the S&P/TSX Composite Index. Over five years, only 19.57% of active managers beat the same Index.

Active managers in the International Equity category saw only 21.21% outperforming their benchmarks; even fewer Global Equity managers, at 12.77%, managed to do so. Over five years, only 10% of International, and 5.26% of Global equity managers beat their comparable Indexes.

Managed U.S. equity funds available to Canadians performed the worst of all. Over the previous five-year period, only 5.13% of funds in this category outperformed their comparable index. These funds carry not only normal market risk, but also currency risk — which likely contributed to their dismal performance record.

To quote from the SPIVA report’s conclusion: “The only consistent data point we have observed over a five year horizon is that a majority of active equity managers in most categories lag comparable index benchmarks.”

This latest SPIVA report mirrors its findings of every year that the report has been issued. The average mutual fund investor has at best, only about a 20% chance of beating the comparable market index over any five-year period.

So why do so many Canadians continue to invest in mutual funds?

The probable key reason is that mutual funds are pro-actively sold to Canadians by their advisors, on the false premise — despite all evidence to the contrary — that mutual funds are the best way to invest.

The untold story however, is that mutual funds do provide the best annual return — not to the investor, but rather to the advisor selling the products.

In Canada, the average mutual fund carries an annual Management Expense Ratio (MER) of approximately 2.4%. Other miscellaneous mutual fund costs can easily add another 0.2% to the total annual expense charged to the investor.

The advisor/seller of mutual funds receives, annually, as much as one-half the total MER assessed.

As the continuing evidence shows, no matter how good the active fund manager, it is extremely difficult to both overcome an annual expense of this magnitude, and still outperform the comparable index.

Notwithstanding the poor track record of relative performance, it is the active-fund providers and advisor sales force who continue to thrive, at the expense of individual investors.

Although awareness is growing, another key reason for the average Canadian investor’s continuing investment in mutual funds is that only a minority are aware of the availability, and utility, of Exchange-Traded Funds (ETFs), and Index Funds. Once informed of the benefits of these options, most investors make the switch, moving out of mutual funds. They discover that ETFs and Index Funds deliver the same degree of diversification as do mutual funds, but often at one-fifth, or less, of the cost. This lower cost usually translates into much higher long-term returns.

As the new mandatory disclosure requirements come into effect in mid-2016, advisors will be forced to make specific disclosure of all fees charged and the amount of benefit they personally derive from each product sold.

This will not only improve Canadians’ awareness of the high costs of their mutual fund investments, but also spur them to seek smarter and cheaper alternatives.

Until then, hopefully this article, and others like it, will continue to encourage the current trend away from mutual funds, in favor of ETFs and Index Funds.

To read its informative detailed report, go to the SPIVA Canada Scorecard website.

 

A retired corporate executive, enjoying post-retirement as an independent Financial Consultant (www.dolezalconsultants.ca), Peter Dolezal is the author of three books, including his recent Second Edition of The SMART CANADIAN WEALTH-BUILDER.