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'It's a question of faith'

For those on the sidelines, it's a confusing debate with each side using selective data to make their case, KEITH DAMSELL writes

When it come to feuds, the U.S. South has the Hatfields and the McCoys; cartoons have Wile E. Coyote and the Road Runner; and the open skies, Air Canada and WestJet Airlines Ltd.

And in the mutual fund sector, nothing gets tempers riled like the debate over active fund management versus passive index investing.

"It's a religious debate. It's a question of faith," said John De Goey of Toronto's Assante Corp.

The financial adviser is in the passive camp, favouring lower-cost funds that mirror the performance of a market index over an actively-managed fund.

The bulk of fund managers are regularly trumped by the index while the handful able to beat the benchmark owe it all too blind luck, Mr. de Goey said. "Does anybody ever interview a lottery winner and say how do you do it?" he asked.

Those are fighting words to Murray McLean, chief investment officer at SEI Investments Canada. Too many investors chase last year's hot mutual fund and are disappointed when returns fall short of expectations, he said. As a result, they dump a stock-picking manager in favour of an exchange-traded fund and have little sense of the risks of passive investing.

For example, Nortel Networks Corp. was worth close to $400-billion at its peak in 2000, a staggering value equal to about one-third of the former TSE 300 index. The shares of the troubled telecommunications company fell through the floor and ETFs took a beating, Mr. McLean said. He fears small investors could face the same calamity when about 50 high-flying income trusts are added to the S&P/TSX composite index later this year.

"I don't think you want to own every one of them," he said. "You don't want to invest in something passively that may take a haircut."

For those on the sidelines, it's a confusing debate with each side using selective data to make their case. On Jan. 31, Russell Investment Group reported active managers outperformed the S&P/TSX in the fourth quarter of last year. The median large-cap Canadian equity manager posted a return of 7.8 per cent, roughly 0.6 per cent ahead of the benchmark index's return of 7.2 per cent.

Then, two days later, Standard & Poor's reported returns for 2004 showed that only 23.6 per cent of actively managed Canadian equity funds outperformed the TSX index.

"There's lots of contrary data," said Michael Morrow of Morrow Financial & Insurance Services in Thunder Bay, Ont. "It gets so complicated you don't know which one is better."

Data can be very misleading and "it all depends on how you slice it," concedes Howard Atkinson, head of public funds at Barclays Global Investors Canada. The Toronto company is Canada's leading index fund provider and has about $9-billion in assets under management in its iUnits group of funds.

Mr. Atkinson admits index funds do not beat every actively managed fund -- but they do beat most of them. That message, along with the appeal of greater transparency and lower annual costs to the unit holder, is "getting out," he said. At present, about 4 per cent of Canadian investments are in indexed funds, a figure he expects will soon match the 10-per-cent average indexed by U.S. investors.

"It's not an either-or-proposition. It's what percentage do you put into indexing strategies at the core of your portfolio," he said.

David Feather, president of Mackenzie Financial Services Inc., is arguably the fund industry's most vocal active management supporter.

"I could go on about this forever," he said, rattling off a long series of figures on the debate.

For example, Canadian market data from the past five years indicate that in a bull markets, active funds report an average gain of 17.2 per cent while index funds are up 22 per cent. But in a bear market, active fund managers are better equipped to handle the downside, losing an average of 8.3 per cent versus a 14.8-per- cent loss for passive funds.

In other words, active managers capture only 78 per cent of the market's upside but more importantly, are limited to 56 per cent of the downside, Mr. Feather said.

He advises investors do their homework and find a good fund manager with a long track record of solid returns, a list that includes Bill Miller, a CI Fund Management Inc. star manager that has beaten the Standard & Poor's 500 index for 13 straight years, and Mackenzie's Jerry Javasky, manager of the Mackenzie Ivy Canadian Fund.

"What it really comes down to is good fund managers are going to be good fund managers," Mr. Feather said. "It's more about did you get the right advice and were you in the right range of funds, than it is about on average did a fund beat the index."

10 biggest Canadian equity funds versus benchmark index

Index investing had competitive returns over the last 15 years, as of Dec. 31, 2004.

Fund nameNet assets ($million)1-year return3-years returns5-years returns10-years returns15-years returns
Mackenzie Ivy Canadian$5,346.58.8%4.0%6.8%9.9% -
Trimark Select Canadian Growth3,720.610. -
RBC Canadian Equity3,662.512.
Fidelity True North-A3,077.714.56.26.3 - -
CI Canadian Investment2,844.215.211.312.113.49.0
AIC Diversified Canada2,748. -
CI Harbour2,724.215.78.310.0 - -
Investors Canadian Equity (all classes)2,682.513.
AFG Canadian Large Cap Dividend2,600.615.17.26.911.09.6
Fidelity Canadian Growth Company-A2,317.417. -
S&P/TSX Total Return 14.5% 8.3% 3.6% 10.1% 8.2%


© 2007 The Globe and Mail. All rights reserved.

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