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S&P/TSX index outpaces managed funds

Passive investment approach beat efforts of 80% of active equity funds in first half


The performance of the S&P/TSX composite index in the first six months of this year beat a stunning 80 per cent of Canadian equity funds, stoking the fires of a heated dispute over active fund management compared with passive index investing.

What's more, research released yesterday by Standard & Poor's Corp. indicates a passive index fund may be the best long-term bet too. Over the past five years, only 43 per cent of Canadian equity fund managers beat the returns posted by the S&P/TSX index.

The short- and long-term returns of the majority of U.S. equity fund managers, meanwhile, were trumped by the Standard & Poor's 500-stock index, the company said. The bulk of actively managed small-capitalization equity funds beat the S&P/TSX small-cap subindex in the first two quarters of this year, but lag it over five years.

"Active managers were not doing better than the index," said Steve Rive, S&P's vice-president of Canadian index services. He stressed that his firm is neither for nor against active or passive management, a confusing debate that has seen each side use selective data to make their point.

"We let the facts prove themselves," Mr. Rive said. "There is such a thing as active risk. This is a risk that the fund you have chosen won't beat the index. And therefore you should choose carefully."

Nevertheless, the data prompted some circling of the wagons by the active-fund camp. Joe Canavan, head of Toronto's Assante Corp., said the TSX's recent gains were an "anomaly" when compared with global equity markets. Long-term passive index investing guarantees "mediocre" returns and fails to address an investor's specific needs, he said.

"A single product is a different game," Mr. Canavan said. "To build a portfolio based on risk-reward objectives and tolerance, monitor it on an ongoing basis and having someone there to counsel you . . . that is something else."

The surging energy sector helped drive the TSX benchmark index up 7 per cent in the first six months of the year, a "narrow" market move that favours index investing, said David Feather, president of Mackenzie Financial Services Inc. According to the Toronto company's research indicates Canada's largest equity funds have "by and large outperformed" the index over the past five and 10 years, he said.

But fund management costs paid by the investor tip the scales in favour of index investing, said Rajiv Silgardo, president of Barclays Global Investors Canada. The Toronto company is this country's leading index fund provider and has about $10.3-billion in assets under management in its iUnits group of funds.

Annual management expense ratios of 2.5 per cent "are a huge hurdle for any manager, no matter how skilled they are, to consistently have to overcome to deliver value-added over and above what a[n] . . . indexing strategy delivers," Mr. Silgardo said.

Gene Hochachka, a portfolio strategist at Edmonton's ATB Investment Management, has clients in a mix of active and passive funds. Typically, index funds excel in a strong bull market while active funds outperform in a weak bear market, he said.

"Twenty per cent of the time they're [index funds] a very poor idea; 80 per cent of the time, they're a great idea," Mr. Hochachka said.

© 2007 The Globe and Mail. All rights reserved.

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