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The Canadian Financial Advisor

It’s not your fund manager, it’s you.

Benjamin Felix

Actively managed investment strategies are not inherently bad, they just introduce a different kind of risk to the investment experience. A well-diversified passive investor chooses to own the market as a whole, taking on market risk. An active manager is making a promise to not own the market as a whole, but to instead select a subset of securities within the market that they believe will perform better than the market. The additional risk added by not owning the market as a whole is called active risk.

Active managers themselves are not bad people. They will likely work extremely hard to research securities and trends in their effort to deliver above-market returns. The problem that active managers have is that, statistically, it is extremely unlikely that they will be able to deliver on their promises. It is by no lack of effort or resources, but simple mathematics. Active investors invest in the market. In aggregate, the average return of all active investors will be the return of the market, less their fees. Based on this simple arithmetic, less than half of active managers should be expected to outperform the market after their fees.

Further to this, we know empirically that in any given year a disproportionately large portion of market returns come from a small number of the stocks in the market. This makes outperforming the market a greater challenge as it requires the identification of the relatively small number of stocks that can drive outperformance.

Fund performance data backs these assertions up. As at June 2016, the S&P SPIVA Canada Scorecard shows that only 28.77% of Canadian domiciled Canadian Equity mutual funds have outperformed their benchmark index (S&P/TSX Composite) over the trailing five-year period. In the Canadian domiciled US Equity mutual funds category, 0.00% of actively managed funds were successful in outperforming their benchmark index (S&P 500 in CAD) over the trailing five years.

This information is available to everyone, but, based on the dollars invested in actively managed funds compared to passive index funds, most Canadians continue to invest their money in actively managed strategies. The decision to invest this way is either driven by a lack of information, or greed. In either case, when Canadian investors inevitably suffer from poor investment performance and high fees, they are themselves as much to blame as anyone else.

Original post at pwlcapital.com