Rob Carrick, financial journalist extraordinaire, interviewed the president of Mackenzie Financial Services, one of the biggest sellers of mutual funds in Canada. In the article, Mr. Feather extols the virtues of mutual funds and how they are apparently so much better than exchange-traded funds. Aside from the inherent bias he has against an investment vehicle that has drawn millions of investment dollars away from traditional actively managed mutual funds, his arguments just don't hold water. Mr. Carrick does a fine job of pressing him for rational answers, but Mr. Feather seems to be trying to convince himself, if not the readers, that the funds in which he invests are a much better place to put his money than ETFs.
Let's evaluate his arguments. For comparisons I will compare funds of similar asset classes offered by Mr. Feather's company to TD e-series index funds. I'll stick to Canadian equity, US equity, international equity, and fixed income to keep it simple. I will only compare these to the no-load funds offered by Mackenzie Financial Services as Mr. Feather claims in the article, despite evidence to the contrary, that "the vast majority of investors" are not paying front-end loads or rear-end loads. This will also give a hand up to Mr. Feather's team, because it will only consider the management expense ratio (MER) of funds, and not the sales loads which many investors would be hit by in reality, because many do not know any better and get suckered into them by dishonest fund salespeople. As well, we will consider TD e-series index funds because they can be purchased at no commission using TD EasyWeb which will eliminate Mr. Feather's argument about trading commissions with ETFs. Here goes.
1. The active management approach leads to a steadier course of investing. Verdict: Bogus
One need not look at individual funds to debunk this notion. If you compared a diversified portfolio of 60% stocks and 40% fixed income to a portfolio consisting entirely of a 4% GIC, you'd say based on this logic that the GIC is much better because it has a steadier course, ie. less volatility. That is absolutely true. But the diversified portfolio would have returned 10% per year from 1970-2008, instead of 4% for the GIC. Return is almost always positively correlated with risk. If you want better returns, you have to take on a bit more risk.
2. It's not true that mutual funds perform worse than ETFs/index funds. Although they lag the index, this is not fair because the index cannot be purchased. Index funds and ETFs still have a cost. Verdict: Bogus
The core of the argument is sound. Merely showing that mutual funds lag the index on average is no indication of their appropriateness as an investment. Index funds and ETFs usually lag the index a bit too. But Mr. Feather does not consider what one might find if you did compare apples to apples, to draw from his response.
Asset Class: Canadian Equity: 5-Year Annualized Return
BMO Equity: 2.7%
TD Canadian Index-e: 2.5%
Asset Class: US Equity: 5-Year Annualized Return
BMO US Equity: -3.5%
Mackenzie Universal US Blue Chip Class: -4.2%
TD Dow Jones Average Index-e: -5.3%
Asset Class: International Equity: 5-Year Annualized Return
Mackenzie Focus International Class: -1.2%
TD International Index-e: -2.8%
Asset Class: Canadian Fixed Income: 5-Year Annualized Return
TD Canadian Bond Index-e: 4.5%
Mackenzie Sentinel Bond Series M: 4.0%
It appears there are actively managed funds that do beat the TD e-Series funds. But there are two problems. First of all, in the above examples, the actively managed funds listed are literally the only ones I found on the list that beat TD. If you can pick these winners out of the vast crowd, be my guest. The other thing one notices when doing this research is that when you rank the available funds by annualized 5-year return, index funds crowd out the top spots. One or two active funds make an appearance, but the majority don't show up until you've run through all available index funds. That should tell you something. Besides, the whole argument disregards the vast body of evidence showing that passive funds regularly outperform active funds, usually by a figure eerily similar to the difference between the operating expenses of the respective funds. Finally, just as a poke against Mackenzie, although their funds seemed to do strangely well in this experiment, all of the funds mentioned above only have no-load as an option. Most people buying these funds through advisors would wind up paying a load. This would eliminate any apparent advantage.
3. Most investors are not paying sales charges on funds. Verdict: Bogus
All available open-ended funds of all asset classes on GlobeFund.com: 6972
Same as above but with no-load: 1919
Therefore, almost 3/4s of available funds have a load.
What about ones the average joe can afford ie. minimum investment of less than $1000?
5058 in total, of which only 1244 have no sales charges. And those 1244 would include funds that have no-load as an option, not as a given.
4. Cost is not the most important variable when selecting an investment. Verdict: Bogus
A study done by Morningstar showed that from 1995 on, funds with the highest costs compared to their peers were almost twice as likely to cease to exist. Funds in the cheapest quintile were twice as likely to beat the average in their category than those in the priciest quintile. There was a direct inverse correlation between cost and performance. As you went up each quintile of cost, you continued to decrease your chances of beating the average. Bond funds were the most stark with the cheapest being 5-6 times more likely to succeed than the most expensive. The study also compared performance to the lowest cost index fund. Interestingly, the cheapest active funds beat the index fund 29% of the time, while the most expensive beat it only 17% of the time. This supports two points: cost is one of the most important variables to consider when selecting an investment, and the majority of active funds, even the cheapest, can't beat index funds.
5. I would challenge people to find a meaningful global equity fund in this country that over the past 10 years has not beaten the index. Verdict: True, if you remove the word 'not' near the end of the sentence.
Challenge accepted. Of the 282 international equity funds on Morningstar.ca, only 12 have beaten the MSCI EAFE index over 10 years. Of those, 9 have sales charges, without the option of no load. Goodbye advantage. Of the remaining 3, 2 have an initial investment of more than $5000. That leaves CIBC International Small Companies, producing a 3.2% annualized return over 10-years versus the index average of -1.8%. How about global equity? 908 are listed on Morningstar. The MSCI World 10-year annualized return is -0.8%. A whopping 34 beat the index. Only 1 of those has no sales charges: TD Entertainment and Communications.
There you have it. Obviously the president of a major mutual fund company would have you believe they're a superior investment. The data just does not support it. So stick to low-cost index investing and you can't really go wrong.
Saturday, February 21, 2009
Saturday, February 14, 2009
The power of hindsight
In order to drive home my previous message about not buying actively managed mutual funds for your retirement portfolio, I've run a little experiment.
I picked up the most recent edition of MoneySense, the greatest magazine on the planet. In it were this year's Honor Roll mutual funds. The author, Suzane Abboud, picks what she thinks are the best mutual funds in each category to guide readers in choosing quality funds for their portfolio. So I thought, surely if this woman who spends her time doing nothing but researching and recommending mutual funds recommends these funds, they must be able to beat a passively constructed index portfolio. Let the battle ensue!
My currently planned portfolio is called the Modified TD e-Series Simple Recipe Portfolio. I will be using all TD e-Series funds, because you can purchase them online through TD EasyWeb for no commission charge and no annual account fees. Plus, they are index funds so they merely track the index with super low management costs. The portfolio asset allocation will be as follows:
TD Canadian Bond Index-e: 40%
TD Canadian Index-e: 30%
TD International Index-e: 20%
TD Dow Jones Average Index-e: 10%
If I had invested $900 a month in this portfolio starting on March 1, 2002, my cumulative return today would be 1.4%. Although that seems paltry, it relatively kicks ass to the -25% I've seen with some actively managed portfolios I tested.
How do the Honor Roll mutual funds stack up? Well, I originally back tested the performance of this year's Honor Roll funds. They did very well, returning 7.2%, clobbering my return. Problem is, I would not have had the foresight to pick these funds in 2002. In fact, neither did Ms. Abboud. (Her 2002 recommendations were strikingly different to those in 2009.) The current crop of Honor Roll funds is largely based on past performance. But what good is past performance unless you can invest in the past?
What advice would a reader in 2002 have received from Ms. Abboud? I went back to the MoneySense archives and took a look at her column in the 2002 February issue. None of the best funds listed in the 2009 issue appeared. So I put together a portfolio of the best funds she listed that the average joe could actually afford (I excluded funds with minimum initial investments of more than $5000, except in one case) and back tested how one would have done investing $900 a month since March 1 of 2002, shortly after the February issue was released. The competitor portfolio would be as follows:
40% TD Real Return Bond Fund
30% Bissett Canadian Equity-A
20% Mackenzie Cundill Value-A
10% Mawer U.S. Equity
(Note: Mawer US Equity has a $10 000 minimum but it was much cheaper than the other US honor roll funds. One had a minimum of $150000. What?)
So had you shunned index funds in 2002 and took the advice of a professional mutual fund analyst and put your money in this portfolio your return from March 1, 2002 until now would be............dunh dunh dunh.....-5.7%
That is a negative sign in front of that number folks. So all that work meeting minimum investments, all those trailer fees paid to your broker or advisor, and all those potential sales charges paid for investing in the funds, just to get -5.7%.
So stick with what works. The main driver of fund performance is expense and index funds are the cheapest, so by mathematical reasoning, they are destined to do better in the long run then actively managed mutual funds. Besides, who wants to spend their time picking winners out of a crowd of 3000 mutual funds when you can do something simple like the MoneySense Couch Potato Portfolio using TD e-series funds and get better results?
I picked up the most recent edition of MoneySense, the greatest magazine on the planet. In it were this year's Honor Roll mutual funds. The author, Suzane Abboud, picks what she thinks are the best mutual funds in each category to guide readers in choosing quality funds for their portfolio. So I thought, surely if this woman who spends her time doing nothing but researching and recommending mutual funds recommends these funds, they must be able to beat a passively constructed index portfolio. Let the battle ensue!
My currently planned portfolio is called the Modified TD e-Series Simple Recipe Portfolio. I will be using all TD e-Series funds, because you can purchase them online through TD EasyWeb for no commission charge and no annual account fees. Plus, they are index funds so they merely track the index with super low management costs. The portfolio asset allocation will be as follows:
TD Canadian Bond Index-e: 40%
TD Canadian Index-e: 30%
TD International Index-e: 20%
TD Dow Jones Average Index-e: 10%
If I had invested $900 a month in this portfolio starting on March 1, 2002, my cumulative return today would be 1.4%. Although that seems paltry, it relatively kicks ass to the -25% I've seen with some actively managed portfolios I tested.
How do the Honor Roll mutual funds stack up? Well, I originally back tested the performance of this year's Honor Roll funds. They did very well, returning 7.2%, clobbering my return. Problem is, I would not have had the foresight to pick these funds in 2002. In fact, neither did Ms. Abboud. (Her 2002 recommendations were strikingly different to those in 2009.) The current crop of Honor Roll funds is largely based on past performance. But what good is past performance unless you can invest in the past?
What advice would a reader in 2002 have received from Ms. Abboud? I went back to the MoneySense archives and took a look at her column in the 2002 February issue. None of the best funds listed in the 2009 issue appeared. So I put together a portfolio of the best funds she listed that the average joe could actually afford (I excluded funds with minimum initial investments of more than $5000, except in one case) and back tested how one would have done investing $900 a month since March 1 of 2002, shortly after the February issue was released. The competitor portfolio would be as follows:
40% TD Real Return Bond Fund
30% Bissett Canadian Equity-A
20% Mackenzie Cundill Value-A
10% Mawer U.S. Equity
(Note: Mawer US Equity has a $10 000 minimum but it was much cheaper than the other US honor roll funds. One had a minimum of $150000. What?)
So had you shunned index funds in 2002 and took the advice of a professional mutual fund analyst and put your money in this portfolio your return from March 1, 2002 until now would be............dunh dunh dunh.....-5.7%
That is a negative sign in front of that number folks. So all that work meeting minimum investments, all those trailer fees paid to your broker or advisor, and all those potential sales charges paid for investing in the funds, just to get -5.7%.
So stick with what works. The main driver of fund performance is expense and index funds are the cheapest, so by mathematical reasoning, they are destined to do better in the long run then actively managed mutual funds. Besides, who wants to spend their time picking winners out of a crowd of 3000 mutual funds when you can do something simple like the MoneySense Couch Potato Portfolio using TD e-series funds and get better results?
Tuesday, February 10, 2009
Food for thought
I know it's been over a month since I posted. But I've been doing two things in my free time this last month that have kept me from posting.
First of all, I've been focussing on Weight Watchers, working toward my goal of shedding 30 pounds. I am down over 26 lbs now in 13 weeks. For anyone that has tried losing weight in the past and been unsuccessful, I would highly recommend Weight Watchers.
As for my other pet project, I've been researching some stocks to start an investment with a small amount of fun money. I've also been deciding what to do with our family's investments as we have to transfer them out of an institution in Ontario. After all the research and interviewing numerous financial advisors, we've decided to go it alone and will be using a low-cost index fund strategy through TD EasyWeb. I started thinking after all the reading I've been doing, that a lot of people are losing a lot of money for lack of knowledge. So I thought I would share with you some of the things I've learned along the way.
Most people if asked right now why their portfolio has done so poorly would say it's the recession. But using GlobeInvestorGold to construct a pretend portfolio of low-cost index funds, I found that had I been investing $900 a month starting on Dec 31, 2003, I would be sitting at just below 0% growth. This is much better than a comparable actively managed portfolio which would have me sitting at -20-30%. Why the discrepancy?
If you don't already know, actively managed mutual funds are the mutual funds most of us hold. They are run by money managers who decide what to buy and sell within the fund. Problem is, you pay anywhere from 1-3% of your investment just to keep the fund running, so right from the get go you're behind. Plus, historically, actively managed funds have been notoriously poor at matching or beating the performance of the broad stock market. So when index funds came along the question became: if my fund manager can't beat the index, why don't I just invest in the index? And now you can. For example, if you buy the TD Canadian Index e-series fund online through TD Easy Web or TD Waterhouse, you will pay less than 0.5% for the management of the fund. Because all the fund aims to do is exactly track the Canadian Index, usually meaning the group of companies that are traded on the Toronto Stock Exchange. So if a company is sold on the index, so does the fund, and if one is bought, so does the fund. So no, you'll never be the guy at the barbecue that can boast about his index-beating fund, but you'll also likely never be the one whining about how badly your fund did. You'll always be just average.
How poorly do actively managed funds perform? Over at Div-Net they've got a great table showing what percentage of actively managed funds have been trounced by the index. It's not pretty. On average, 65-70% of actively managed funds were outperformed by the benchmark by which they measure their performance. The numbers are roughly 50-60% for Canadian funds, based on what I've seen in other sources.
Now you might ask, "But if I can pick the 40% of funds that do outperform the index, I'll be laughing. The problem is, there's almost no way of knowing. I'm currently reading one of the most seminal texts ever written on investing, The Intelligent Investor by Benjamin Graham (mentor and teacher of Warren Buffett, currently richest man in the world). In it he describes the problems inherent in picking winning mutual funds. First place most people would look is past performance. The problem is that most good performers have a nasty habit of becoming tomorrow's poor performers often because they were good performers because they were overweighted in the "industry of the minute". So for example in the late 1990s, many technology heavy funds were posting 100+% gains because of growth in the Internet sector. When it all came crashing down, so did their returns. Had you looked at these funds at the tail end of the success, you would have been crushed. Conversely, funds that were at the time underperforming because the manager refused to get caught up in the Internet craze of the time ended up performing very well when the tech sector crashed.
But the bottom line is, picking a winning fund is like playing roulette. The odds are stacked in favor of the house. If a fund is exactly tracking the index, but charging 2.5% to manage the fund, how do you think it performs in relation to the index? That's right, almost exactly 2.5% below the index. In fact, the number one factor determining fund performance over time is cost of operating the fund. Higher fees are in no way offset or justified by superior performance. In fact, quite the opposite is true.
So why isn't everyone invested in index funds, as my astute wife would ask? Well, the financial services industry is heavily invested in selling you actively managed funds. What would all those money managers do? Where would the companies get their commissions, trailer fees, and sales charges from without active funds? Even a TD advisor I interviewed who I ended up not going with tried to feed my the bulls&%t line that active funds are justified in their cost because they produce better performance. Nice idea but the evidence doesn't bear it out. But good luck to you if you can find an advisor willing to deal with you if you want to invest in index funds. This advisor flat out told me she would not allow me to purchase index funds through her, of course justifying the answer by saying that she was only saying this because it was in the best interest of my portfolio performance. A bunch of crap indeed.
So, if you want to invest in index funds, you'll be going it alone. You can invest in them through TD EasyWeb or Waterhouse, although I'd recommend EasyWeb unless you have $25000 in each account or more, because Waterhouse pins you with $100 annual account fees. You can also invest in index funds from other companies through one of the many online discount brokerages like QTrade or Etrade. But as for advice, either learn it yourself, or find a fee-only advisor who will give you advice outside of your investment account. That's the way I'm going now.
To all of you out there who are currently poo-pooing the whole notion of investing and wanting to stuff your money in a mattress for the next 30 years, consider the following. Right now, stocks are at historically low levels. If Wal-Mart put your favorite coffee on sale tomorrow would you run out and buy it or panic and sold the remaining cartons you had at home? As welll, each generation of investors suffers recessive amnesia when a market crash occurs, assuming this is the worst and it will remain down forever. But periods of low market activity have the wonderful habit of being followed by higher than normal activity. Three points I urge you to consider.
1. Using the Stingy Investor Asset Mixer I tracked the performance of the portfolio I've chosen since 1973 to present (35 years, conveniently the time from now to my retirement!). I would have experienced a respectable 10% annual gain. That is more than I used in my retirement projections.
2. Looking at the past 183 years of US stock market data, Ed Rempel, a certified financial planner, has shown the following:
-2008 was an exceptional year in stock market history; only 1937 and 1931 have experience larger losses
-most large loss years are followed by large gain years
-70% of the entire history of the US stock market has been in positive years; in fact, 46% of the years studied have experienced gains of 10% or greater
-large gains are much more common than small ones: 25 years gained over 30% but only 3 lost over 30%
3. We are and we are not at a very unique time in financial history. Preet over at WhereDoesAllMyMoneyGo.com has a great link to a series of Time Magazine covers over the last 30 years with relation to stock markets. It is enlightening to see how similar things have been at many points in the past and how well they rebounded.
So is now the time to run and hide? No, now is the time to invest!
First of all, I've been focussing on Weight Watchers, working toward my goal of shedding 30 pounds. I am down over 26 lbs now in 13 weeks. For anyone that has tried losing weight in the past and been unsuccessful, I would highly recommend Weight Watchers.
As for my other pet project, I've been researching some stocks to start an investment with a small amount of fun money. I've also been deciding what to do with our family's investments as we have to transfer them out of an institution in Ontario. After all the research and interviewing numerous financial advisors, we've decided to go it alone and will be using a low-cost index fund strategy through TD EasyWeb. I started thinking after all the reading I've been doing, that a lot of people are losing a lot of money for lack of knowledge. So I thought I would share with you some of the things I've learned along the way.
Most people if asked right now why their portfolio has done so poorly would say it's the recession. But using GlobeInvestorGold to construct a pretend portfolio of low-cost index funds, I found that had I been investing $900 a month starting on Dec 31, 2003, I would be sitting at just below 0% growth. This is much better than a comparable actively managed portfolio which would have me sitting at -20-30%. Why the discrepancy?
If you don't already know, actively managed mutual funds are the mutual funds most of us hold. They are run by money managers who decide what to buy and sell within the fund. Problem is, you pay anywhere from 1-3% of your investment just to keep the fund running, so right from the get go you're behind. Plus, historically, actively managed funds have been notoriously poor at matching or beating the performance of the broad stock market. So when index funds came along the question became: if my fund manager can't beat the index, why don't I just invest in the index? And now you can. For example, if you buy the TD Canadian Index e-series fund online through TD Easy Web or TD Waterhouse, you will pay less than 0.5% for the management of the fund. Because all the fund aims to do is exactly track the Canadian Index, usually meaning the group of companies that are traded on the Toronto Stock Exchange. So if a company is sold on the index, so does the fund, and if one is bought, so does the fund. So no, you'll never be the guy at the barbecue that can boast about his index-beating fund, but you'll also likely never be the one whining about how badly your fund did. You'll always be just average.
How poorly do actively managed funds perform? Over at Div-Net they've got a great table showing what percentage of actively managed funds have been trounced by the index. It's not pretty. On average, 65-70% of actively managed funds were outperformed by the benchmark by which they measure their performance. The numbers are roughly 50-60% for Canadian funds, based on what I've seen in other sources.
Now you might ask, "But if I can pick the 40% of funds that do outperform the index, I'll be laughing. The problem is, there's almost no way of knowing. I'm currently reading one of the most seminal texts ever written on investing, The Intelligent Investor by Benjamin Graham (mentor and teacher of Warren Buffett, currently richest man in the world). In it he describes the problems inherent in picking winning mutual funds. First place most people would look is past performance. The problem is that most good performers have a nasty habit of becoming tomorrow's poor performers often because they were good performers because they were overweighted in the "industry of the minute". So for example in the late 1990s, many technology heavy funds were posting 100+% gains because of growth in the Internet sector. When it all came crashing down, so did their returns. Had you looked at these funds at the tail end of the success, you would have been crushed. Conversely, funds that were at the time underperforming because the manager refused to get caught up in the Internet craze of the time ended up performing very well when the tech sector crashed.
But the bottom line is, picking a winning fund is like playing roulette. The odds are stacked in favor of the house. If a fund is exactly tracking the index, but charging 2.5% to manage the fund, how do you think it performs in relation to the index? That's right, almost exactly 2.5% below the index. In fact, the number one factor determining fund performance over time is cost of operating the fund. Higher fees are in no way offset or justified by superior performance. In fact, quite the opposite is true.
So why isn't everyone invested in index funds, as my astute wife would ask? Well, the financial services industry is heavily invested in selling you actively managed funds. What would all those money managers do? Where would the companies get their commissions, trailer fees, and sales charges from without active funds? Even a TD advisor I interviewed who I ended up not going with tried to feed my the bulls&%t line that active funds are justified in their cost because they produce better performance. Nice idea but the evidence doesn't bear it out. But good luck to you if you can find an advisor willing to deal with you if you want to invest in index funds. This advisor flat out told me she would not allow me to purchase index funds through her, of course justifying the answer by saying that she was only saying this because it was in the best interest of my portfolio performance. A bunch of crap indeed.
So, if you want to invest in index funds, you'll be going it alone. You can invest in them through TD EasyWeb or Waterhouse, although I'd recommend EasyWeb unless you have $25000 in each account or more, because Waterhouse pins you with $100 annual account fees. You can also invest in index funds from other companies through one of the many online discount brokerages like QTrade or Etrade. But as for advice, either learn it yourself, or find a fee-only advisor who will give you advice outside of your investment account. That's the way I'm going now.
To all of you out there who are currently poo-pooing the whole notion of investing and wanting to stuff your money in a mattress for the next 30 years, consider the following. Right now, stocks are at historically low levels. If Wal-Mart put your favorite coffee on sale tomorrow would you run out and buy it or panic and sold the remaining cartons you had at home? As welll, each generation of investors suffers recessive amnesia when a market crash occurs, assuming this is the worst and it will remain down forever. But periods of low market activity have the wonderful habit of being followed by higher than normal activity. Three points I urge you to consider.
1. Using the Stingy Investor Asset Mixer I tracked the performance of the portfolio I've chosen since 1973 to present (35 years, conveniently the time from now to my retirement!). I would have experienced a respectable 10% annual gain. That is more than I used in my retirement projections.
2. Looking at the past 183 years of US stock market data, Ed Rempel, a certified financial planner, has shown the following:
-2008 was an exceptional year in stock market history; only 1937 and 1931 have experience larger losses
-most large loss years are followed by large gain years
-70% of the entire history of the US stock market has been in positive years; in fact, 46% of the years studied have experienced gains of 10% or greater
-large gains are much more common than small ones: 25 years gained over 30% but only 3 lost over 30%
3. We are and we are not at a very unique time in financial history. Preet over at WhereDoesAllMyMoneyGo.com has a great link to a series of Time Magazine covers over the last 30 years with relation to stock markets. It is enlightening to see how similar things have been at many points in the past and how well they rebounded.
So is now the time to run and hide? No, now is the time to invest!
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