None of the mutual funds ranked by S&P in the top quartile in 2019 remained in that tier over the following four years.Mark Blinch/Reuters
For as long as mutual funds have been around, investors have been lured by the archetype of the star fund manager – that gifted stock picker who can divine future champions from the masses of corporate listings.
But don’t be fooled. There is a lot more luck than skill involved in beating the market. We know that because almost nobody can do it consistently.
Each year, S&P Dow Jones Indices tracks the Canadian mutual fund space to see how long the best performing funds can stay on top.
The answer: not long.
For example, start with the best Canadian stock funds of 2019. There were 162 funds ranked by S&P in the top quartile across a range of categories, including Canadian equities, small caps, dividend stocks, and international stocks.
How many of those mutual funds remained in the top tier over the following four years? Zero. Not a single fund.
“Regardless of asset class or style focus, active management outperformance tends to be relatively short lived, with few funds consistently outranking their peers,” S&P’s director of index investment strategy Davide Di Gioia wrote in the report.
Tim Shufelt: Despite high fees, Canadians remain perplexingly loyal to mutual funds. Here’s why
Clearly, skill is not primarily driving fund performance. Otherwise, there would be some continuity at the top of the market over the years.
It could be that a fund manager’s style happens to work well in the market conditions of a particular year. Or they simply got lucky.
The findings of these reports don’t change much year to year. Nor are they any more favourable to the industry in other markets. U.S. fund managers are just as incapable of maintaining superior results.
But the myth of the stock market savant retains its grip over plenty of everyday investors. “People really want to believe that there’s somebody out there with that magic,” said Graham Bodel, co-founder of Chalten Fee-Only Advisors in Vancouver.
The industry itself does plenty to sell that story, telling investors that deft fund managers can position you for the best opportunities while protecting your money from market selloffs.
An article on CI Global Asset Management’s site makes a case for active management, saying it “offers the potential to outperform the market benchmark, while a passive portfolio will underperform the index due to fees and expenses.”
While this statement is true, few active fund managers live up to that potential.
Last year, 85 per cent of Canadian equity funds underperformed the S&P/TSX Composite Index, according to S&P. And if history is any indication, the thin minority of decent performers will soon lose their standing atop the market.
Some other highlights from the S&P persistence report, none of which are at all flattering to the industry:
- No Canadian funds in the Canadian-focused equity, Canadian small/mid-cap equity, international equity and U.S. equity categories maintained top quartile performance over the last three calendar years. That’s a worse result than you would expect from random chance.
- Only 14 per cent of Canadian equity funds remained in the top quartile over two consecutive five-year periods. Again, worse than random chance.
- Just 4 per cent of active equity funds that beat their benchmarks in 2021 continued their outperformance over the following two years.
It’s not that all these professional investors are bad at what they do. But fund fees are more than offsetting the value added from their investment choices in many cases.
Mutual fund management expense ratios in excess of 2 per cent can easily cost the average investor hundreds of thousands of dollars over an investing lifetime.
But a low-cost index investing approach still seems to be a hard sell for most Canadians. They are told they need not settle for market returns, even though the stock market has proven over decades it can deliver average annual returns of around 10 per cent.
“If you can’t make your financial goals work with 10-per-cent returns a year, the answer is not to go find someone that says they can get higher returns,” Mr. Bodel said.
Past performance is no guarantee of future results. While this is standard mutual fund fine print, it should be considered a hard and fast rule – one that investors ignore at their peril.