OTTAWA (GlobeinvestorGOLD) --Quick, what’s the safer place to be during a bear market for stocks – ETF and index funds, or traditional mutual funds?
You might expect that regular mutual funds would offer more downside protection, given that managers have the latitude to hold cash and move money into defensive sectors. Index funds and exchange-traded funds, of course, passively mirror an index. If the index plunges, they go along for the ride. Strangely, however, it looks like ETFs and index funds can hold up comparatively well in a bear market.
A new study by Standard & Poor’s Index Services found that only 38.9 per cent of actively managed Canadian equity funds outperformed the S&P/TSX capped composite index during the last bear market, which ran from August 2000 to December 2002. Just over 34 per cent of funds that hold large capitalization stocks beat the S&P/TSX 60 index, while only 30 per cent of small-cap funds beat the S&P/TSX smallcap index.
S&P also found that a majority of U.S., international and global equity funds underperformed their respective indexes from August 2000 to December 2002. Global funds did best, with 46 per cent outperforming the benchmark S&P/Citigroup world primary market index.
The obvious lesson here for investors is that ETFs and index funds are not demonstrably inferior to actively managed mutual funds in a bear market, even if this is sometimes suggested by the mutual fund industry. S&P’s study of the last bear market clearly shows that active fund managers don’t always make the right calls to protect their investors from plunging stock indexes.
But let’s not get carried away in praising ETFs and criticizing actively managed funds for their respective results in the last bear market. All mutual funds may not have done well as a group, but some mutual funds certainly did. Index investing doctrine would hold that past performance tells you nothing about the likelihood a fund will outperform the index in the future. But this may not be as true with actively managed funds in bear markets.
The reason is that some active funds are run on conservative principles that strive to protect unitholders by holding large cash positions and through diversification (i.e.: limiting exposure to risky sectors like tech or commodities). There are also managers who stick to undervalued stocks that underperform in the kind of commodity-driven market we’ve seen in recent years, but often excel in bear markets.
Ultimately, S&P’s report tells investors that they shouldn’t count on mutual funds to automatically offer more downside protection in a bear market. But that doesn’t mean you can’t find individual funds that can weather a storm.
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