What are we looking for?
Canadian equity funds that have outperformed their peers on a risk-adjusted basis.
The screen
As investors, emotional biases can skew the perception of our own skillset and discipline. We’ll often hear stories about a stock that popped, or how well a portfolio is doing, but rarely do we hear about the opposite. For these reasons, its imperative to perform a gut-check on how well your own investments have done from time to time, to ensure you are in the best position to reach your financial goals.
To this end, today we look at one of the oldest categories of mutual funds and exchange-traded funds (ETFs): Canadian equities. Some readers might immediately balk at the idea of paying any sort of management fee to a fund company in this category, knowing that management fees are the single consistent detractor to cumulative wealth over time. However, for some, paying that management fee might be worthwhile if it means more certainty around security selection and confidence around a long-standing portfolio manager who was weathered market volatility and has come out on top. Canada’s stock market is also quite cyclical in nature due to heavy energy and natural resources exposure, which requires a degree of skill to navigate.
Today’s screen uses Morningstar Direct to find Canadian-domiciled mutual funds and ETFs in the Canadian equity category (which contains 223 unique funds) to find those that have managed to outperform their peers on an after-fee risk-adjusted basis over a 10-year timeframe. The screen uses the Morningstar Rating for Funds (alternatively known as the “star rating”). The rating methodology includes a unique application of utility theory, which captures the idea that an investor is indifferent between a moderately risky fund generating a 12-per-cent return and a riskless fund generating a 8-per-cent return. In other words, retail investors care more about the downside than the upside. The risk adjustment applied levels the playing field for funds in the same category that have different risk-factor exposures. On aggregate, Morningstar’s data shows that five-star funds outperform four-star funds etc. in periods after receiving the rating. The rating serves as an excellent starting point for further investigation.
Only five-star Canadian-domiciled funds and ETFs were considered. Where applicable, I’ve used the fee-based share class of mutual funds, which separates the fee for advice (charged separately by your adviser) and the fee paid to the fund manager.
What we found
The mutual funds and ETFs that qualified in the screen are listed alongside their trailing performance, management expense ratios (MERs), inception dates, star ratings and the tenure of the longest-standing portfolio manager of the fund. Though not used in the screen, I also display the Morningstar Medalist Rating, which is our analysts’ forward-looking assessment of the fund’s ability to outperform in the future, based on an assessment of people (experience and track record of portfolio managers), parent (the stewardship qualities of the manufacturer) and process (the consistency and risk mitigation approaches used by the fund manager). The list is sorted by 10-year annualized returns. I’ve also included the returns of a well-referenced equity benchmark index, and the average fund in the category.
This article does not constitute financial advice, it is always recommended to conduct one’s own independent research before buying or selling any of the funds or ETFs mentioned in this article.
Ian Tam, CFA, is director of investment research for Morningstar Canada.
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