Cameron Passmore CIM, FMA, FCSI

Portfolio Manager

Benjamin Felix MBA, CFA, CFP

Associate Portfolio Manager
  • T613.237.5544 x 313
  • 1.800.230.5544
  • F613.237.5949
  • 265 Carling Avenue,
    8th Floor,
  • Ottawa, Ontario K1S 2E1

Don’t follow the crowd into cash

It’s easy to imagine that when markets are declining everyone is selling their stocks and hiding cash under their mattresses. Sensationalist news reports will often reference increasing cash balances as nervous investors rush for the exits. While this perception is common, it misses half of the story; for every seller there must be a buyer. Cash isn’t piling up everywhere while everyone waits on the sidelines. For each nervous seller running for the hills, there is a level-headed buyer capturing the equity premium.

When contemplating the action of selling investments to hold cash in anticipation of a market crash, one must consider the following:

Do you know more than whoever is on the other side of the trade? Someone is happily buying the securities that you are in a hurry to sell. In 1980, 48% of U.S. corporate equity was held directly by households, and by 2008 that number had dropped to 20%1, meaning that the someone buying your securities is likely a skilled professional at a large institution; do you know something they don’t?

When are you going to get back in? Markets deliver long-term performance in an unpredictable manner. Over the 264 months from January 1994 – December 2015, a globally diversified equity portfolio returned 8.51%2 per year on average. Removing the five best months reduces that average annual return to 6.46%. That is a 24% reduction in average annual returns for missing 1.9% of the months available for investment. Peter Lynch famously stated "Far more money has been lost by investors preparing for corrections or trying to anticipate corrections than has been lost in corrections themselves."

Should you have been in the market to begin with? If you need your cash in the short-term, it probably shouldn’t be invested in stocks and bonds. If a portfolio has been properly structured to meet a specific financial goal, it should remain in the market regardless of the market conditions. Portfolio volatility can be controlled by selecting an appropriate mix of stocks and bonds, not by jumping between stocks and cash.

A positive investment experience is largely dictated by discipline. There is no evidence that market timing results in better returns, and plenty of evidence that it is detrimental. While it may sometimes seem like everyone is going to cash to avoid a downturn, they’re not. Those choosing to go to cash are effectively being exploited by those taking a disciplined approach, rebalancing into stocks when stocks are declining.

1 Investment Noise and Trends, Stambaugh
2 Dimensional Returns 2.0

By: Ben Felix | 2 comments

Canadian investors are slow to adopt evidence-based investing

It is becoming common knowledge that Canadians pay the highest mutual fund fees in the world, and are often receiving advice from commissioned sales people selling expensive actively managed mutual funds rather than fiduciary financial advisors acting in their best interest. Index funds and passive investing have gone mainstream on Canadian personal finance blogs and media outlets, giving the impression that we are becoming sensible investors. The data tells a different story.

In 2008, 6.9% of Canadian mutual fund and ETF assets were invested in passive vehicles, compared to 21% of U.S. assets. At the end of December, 2015, Canadians’ passive investment assets had increased to 12% , while passive assets in the U.S. had climbed to 32%. In the U.S., the market share of passive investment assets has been increasing each year by an average of 1.75%, while in Canada the passive market share has been flat since 2013, and increased by an average of only 0.65% per year since 2008.

Estimated Canada & U.S. Market Share of Passive and Active Funds 2008-2015

  Passive Active
  Canada U.S. Canada U.S
2008 6.9% 20.8% 93.1% 79.2%
2009 9.0% 21.6% 91.0% 78.4%
2010 9.5% 23.1% 90.5% 76.9%
2011 9.5% 24.4% 90.5% 75.6%
2012 10.6% 25.8% 89.4% 74.2%
2013 11.7% 27.8% 88.3% 72.2%
2014 12.0% 30.1% 88.0% 69.9%
2015 12.1% 32.4% 87.9% 67.6%

Source : Morningstar Direct

Passive investment vehicles in Canada have seen positive net inflows each year since 2008, while flows into active funds have been much more volatile with negative flows in 5 of the last 8 years. The steady flows into passive funds, and the volatility of flows into active funds, support the idea that a passive, evidence-based investment philosophy fosters investment discipline while active management results in performance-chasing behaviour. In 2015, active funds in Canada attracted nearly $15B of assets, while passive funds attracted $8B. Like in Canada, the U.S. has seen consistent positive flows into passive funds, and volatility in active fund flows. In 2015, U.S. investors extracted -$207B from active funds, while pouring a near-record $414B into passive funds.

Estimated Canada & U.S. Net Fund Flows 2008-2015 ($ Billions)

  Passive Active
  Canada U.S. Canada U.S
2008 5.73 216.87 15.85 (207.63)
2009 7.32 190.65 (27.83) 310.24
2010 3.53 194.26 (14.28) 197.00
2011 5.33 193.79 (2.32) 17.35
2012 8.85 273.65 (8.00) 184.46
2013 3.58 324.78 4.21 142.80
2014 4.68 421.49 (2.19) 64.37
2015 7.96 413.87 14.58 (207.29)

Source : Morningstar Direct

The overall trend is that while Canadians are adding assets to passive funds, they are doing so at a much slower pace than Americans. It is possible that this is due to the rise in the Registered Investment Advisor in the U.S.; an RIA is registered with the SEC, is fee-based, and has a fiduciary duty to clients. RIAs tend to use more passively managed investment vehicles. In Canada, the vast majority of investment fund assets are in mutual funds, and the vast majority of mutual fund assets are in commission-based actively managed funds. Most financial advisors in Canada are not legally obligated to act in the best interest of their clients, and their recommendations may be tainted by the need to earn commissions or meet sales targets. Index funds and other low-cost vehicles do not pay commissions.

By: Ben Felix & Raymond Kérzerho | 0 comments

Canadians’ investment decisions may be affected by financial advisors’ reliance on trailing commissions

In Morningstar’s 2015 Global Fund Investor Experience Study, published in June, Canada scored a C+ based on four categories: Regulation and Taxation (C), Disclosure (A-), Fees and Expenses (D-), and Sales and Media (B). As usual, the category that stands out is Fees and Expenses. The average equity fund in Canada has a fee of 2.35%, while the average balanced fund has a fee of 2.16%. One of the most interesting parts of this study is the breakdown of fee-based vs. commission-based funds in Canada. Knowing that the majority of Canadian investment fund assets are in mutual funds, and the majority of mutual assets are commission-based, it begs the question of whether or not investment recommendations are affected by commissions. Low-cost investment products such as index mutual funds and ETFs do not pay deferred sales charge or trailing commissions.

Mutual funds can be obtained by investors in three forms: commission-based, fee-based, and direct. A commission-based fund has a commission for the advisor selling it built into the MER; the net effect is that the fund company rather than the client is paying the advisor. These funds must have higher fees in order for them to pay the advisor, and cover the operating costs of the fund. If an advisor operates on a commission basis, they are likely to use funds that pay commission. A fee-based fund does not pay any commissions; the MER only covers the costs of the fund, and the advisor is left to negotiate a separate fee with the client. Direct funds are purchased without going through an advisor at all.

With such a large proportion of Canadian mutual fund assets in commission-based funds, it is hard to believe that commissions are not playing a role in investment recommendations.

    Percentage of Assets
Fund Type Commission-Based Fee-Based Direct
Domestic Core Balanced - Aggressive 95.6 4.1 0.3
Domestic Core Balanced - Moderate 93.5 4.1 2.4
Domestic Core Balanced - Conservative 96.5 3.2 0.3
Domestic Core Bonds 82.5 9.1 8.4
Domestic Core Equity 90.9 4.4 4.7
Domestic Money Market 90.3 2.4 7.3
Domestic Non-Core Bonds 86.1 11.3 2.6
Domestic Non-Core Equity 84.6 9.4 6.0
Foreign Core Equity 79.6 13.2 7.3
Foreign Money Market 96.4 0.3 3.3
Foreign Non-Core Equity 84.2 13.0 2.8
Global Core Balanced - Aggressive 96.2 2.7 1.1
Global Core Balanced – Moderate 95.8 3.5 0.8
Global Core Balanced – Conservative 94.1 5.8 0.1
Global Core Bonds 58.1 41.2 0.7
Global Core Equity 88.8 10.1 1.1
Global Non-Core Balanced 93.8 4.6 1.5
Global Non-Core Bonds 74.7 20.5 4.8
Global Non-Core Equity 83.7 12.2 4.1
Sector Equity 88.8 9.7 1.5

Source: Morningstar Global Investor Experience Study

By: Ben Felix | 0 comments