This just in: Beating the stock market is quite difficult. While this may strike some readers as rather obvious news, Canadian investors still mostly entrust their money to stock pickers and market timers.
Study after study shows only a tiny minority of elite investing professionals can outperform the market with any kind of regularity, in Canada or elsewhere.
The likelihood of an investor picking one of the few funds that generates market-beating returns is remote. That doesn’t seem to stop multitudes of Canadians investors from trying to beat the odds, and paying dearly for it.
Why? Because the investing public is still widely sold on the idea that they need not settle for market returns.
Dave Ramsey, an American financial guru with one of the country’s top talk radio shows, recently told his millions of listeners: “It’s not really hard to beat the S&P [500]. The S&P is the average of the market.” So, all you have to do is be better than average. While this kinda sorta sounds like it makes sense, it is absolutely false.
Twice a year, S&P Dow Jones Indices produces a scorecard of the investment fund space, country by country. The report compares the performance of actively managed mutual funds to their relevant benchmarks to see how many funds are doing what they claim they can do.
For the first half of this year, about one-quarter of all domestic U.S. equity funds managed to beat the performance of a broad stock index. Not great.
The results get much worse on a longer timeline. On a 15-year basis, the proportion of U.S. stock funds that outperformed their benchmarks was just 6.5 per cent. Yikes.
Plenty of investors in recent years have awakened to the shaky track record of the stock picking business.
The global rise of passive investing
Canadian investors lag the rest of the world in shifting
to a low-cost indexing approach
Assets Under Management (AUM), in trillions of U.S. dollars
Active (%)
Passive (%)
AUM: $1.3
AUM: $22.8
AUM: $38.7
15%
45%
37%
55%
63%
85%
CANADA
U.S.
GLOBAL
the globe and mail, Source: pwl capital
The global rise of passive investing
Canadian investors lag the rest of the world in shifting
to a low-cost indexing approach
Assets Under Management (AUM), in trillions of U.S. dollars
Active (%)
Passive (%)
AUM: $1.3
AUM: $22.8
AUM: $38.7
15%
45%
37%
55%
63%
85%
CANADA
U.S.
GLOBAL
the globe and mail, Source: pwl capital
The global rise of passive investing
Canadian investors lag the rest of the world in shifting to a low-cost indexing approach
Assets Under Management (AUM), in trillions of U.S. dollars
Active (%)
Passive (%)
AUM: $1.3
AUM: $22.8
AUM: $38.7
15%
45%
37%
55%
63%
85%
CANADA
U.S.
GLOBAL
the globe and mail, Source: pwl capital
A global movement has grown around a passive approach to investing championed by the likes of Vanguard, BlackRock, and State Street, and facilitated by the rise of exchange-traded funds. The three companies now control a colossal US$20-trillion in assets under management, as investors have gravitated to a style of investing that seeks to emulate market returns while minimizing costs.
“The shift to passive investing has been driven, in part, by the relatively disappointing and inconsistent performance record of active managers,” Sean Freer, director of global equity indices at S&P Dow Jones Indices, wrote in a recent report.
Over the past 10 years, assets in U.S. passive funds have grown by roughly 230 per cent, compared to just 30 per cent growth in active funds, according to data from PWL Capital.
Even the world’s most famous stock picker, Warren Buffett, is a believer in passive investing.
Mr. Buffett famously placed a friendly wager with a New York-based money management firm that pitted indexing against stock selection. He bet US$1-million that an index fund tracking the S&P 500 would beat a portfolio of hedge funds over a 10-year period starting in 2008.
The hedge funds returned an average of 36 per cent after fees. The index fund gained 126 per cent. “Both large and small investors should stick with low-cost index funds,” Mr. Buffett wrote in a letter to shareholders.
Many have heeded that advice in the U.S., where the passive space is on the cusp of assuming a dominant market share.
Canadian investors, on the other hand, have been far slower to shift their allegiances to indexing. Since 2013, Canadian passive funds increased their market share from 10.4 per cent to just 15.5 per cent currently.
It’s certainly not because the active management space has earned investors’ loyalty. The latest Dow Jones scorecard for Canada shows that just 5.4 per cent of domestic equity funds outperformed the S&P/TSX Composite Index over the past 10 years.
There is currently more than $1.4-trillion of Canadians’ wealth residing in active funds – mostly traditional mutual funds carrying an average management expense ratio of about 1.5 per cent. On the other hand, the average weighted MER on passive funds in Canada is 0.25 per cent.
Take the fee differential, and you get excess fees of more than $17-billion that Canadians are paying each year to remain in actively managed products.
How has ugly performance and steep fees not crushed active investing in Canada? The answer may lie in the question itself.
Investment advisers in Canada are incentivized to sell Canadian investors products with high fees over lower-cost vehicles, through generous commissions on mutual funds.
Canadian asset managers also have considerable control over distribution, allowing them to keep cheaper alternatives at bay. Some big banks have even resorted to stripping their product shelves of independent mutual funds. And most of the banks do not allow their branch-based advisers to sell clients ETFs, keeping lower-cost options out of the hands of many investors.
As long as the active fund business can maintain its grip on power, many Canadians will sit on the sidelines of the passive investing movement.