Twice annually, Standard & Poor’s Index versus Active (SPIVA) group publishes its independent measure of the performance of actively-managed mutual funds vs. that of comparable Index benchmarks. The Canadian scorecard for the period ending June 30, 2016 has recently been released.
Once again, the data confirms the consistent underperformance, over any extended time frame, of mutual funds invested in our domestic equities. Over the previous 12 months, only 26 per cent of funds outperformed the S&P/TSX Composite Index; over three years, 23 per cent outperformed; and over five years, 29 per cent.
An even more shocking underperformance emerged for Canadian mutual funds invested in large cap U.S. stocks. Of the dozens of funds in that category, not one outperformed the S&P 500 Index over the previous five years.
Not surprisingly, over the same five years, only 14 per cent of Canadian mutual funds invested in the International equity sector beat their respective benchmarks.
This sub-par performance of mutual funds has repeated every six months for many years; the numbers vary each period, but point to the same conclusion: investing in mutual funds is not the optimal strategy for investors looking to optimize long-term returns on invested capital.
The reason remains unchanged. The massive annual fees (2.3 per cent) charged by the average Canadian mutual fund are extremely difficult for a fund manager to overcome in any time frame. If the above data were reported without those fees, it would show that the average fund manager did beat the comparable Index in most categories. Unfortunately, high fees remain a reality for both the fund manager and the average investor, with the investor suffering the negative consequences of the resulting underperformance.
As investors become more aware of the adverse impact of high fees, a major investor shift in favour of Exchange Traded Funds (ETFs) and Index Funds is accelerating. ETF investments in Canada have now exceeded $100 billion – still only one-tenth that of the mutual fund sector; however, the gap is narrowing, fast.
Since 2010, the total funds flowing to ETF investments in Canada have more than doubled. As the new “fee transparency” rules become fully implemented by year end, investors’ awareness of the magnitude of high holding costs should accelerate this trend, with annual fees at one-fifth, or even less, those of mutual funds in similar market sectors.
Seeking to eke out an improved return, many investors spend time analyzing which investments to make. Only a few however, consider that reducing a portfolio’s annual holding cost by two per cent produces the same results as improving total annual return by that same two per cent – in any market; rising or falling.
More than 420 individual ETFs are now available for purchase on the TSX. They encompass virtually all sector, geographic, and asset classes covered by mutual funds.
Decades ago, if we wanted to achieve adequate diversification in our investments, mutual funds were our only realistic answer – despite their high fees.
Today we have a choice; more of us should be examining the options.
A retired corporate executive, enjoying post-retirement as an independent Financial Consultant (www.dolezalconsultants.ca), Peter Dolezal is the author of three books, including The SMART CANADIAN WEALTH-BUILDER.