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Indices versus Active F-Class Funds: Is active management worth the cost?

Advisors who continue to praise the merits of passive management need to stop hiding behind reports that indicate how the “average actively managed mutual fund does not beat its benchmark” or how “<insert small percentage here> of actively managed mutual funds do not beat their benchmarks over a 5 year period”.  Most of these studies use data from A-Class mutual funds, a series of funds that pay an ongoing trailing commission to the advisor. Every advisor knows this is not an “apples to apples” comparison to a passive index fund or exchange traded fund (ETF), since the latter normally pays little or no trailing commissions. Comparing the universe of actively managed F-Class mutual funds (which also do not pay trailing commissions) against passively managed investments would help advisors and investors alike decide which of the two management styles should add more value.

By examining the F-Class universe of mutual funds, using Morningstar PALTrak data as of November 30, 2010, I have initially sorted the complete fund list by “Fund Category”. For ease of benchmark comparison, I have limited the analysis to the following categories:  Canadian Fixed Income, Canadian Equity, U.S. Equity, and International Equity. The number of funds in each category is reduced further using the following filters:

  • Only CAD$ funds are included (US$ funds are excluded)
  • Only funds with at least 5 years  of returns history are included
  • Only one share class is included for each fund (usually the corporate class version of the same fund has been excluded)
  • All currency hedged funds are excluded
  • All pooled funds are excluded
  • All index funds are excluded (Note: DFA funds have been included)

The following benchmark indices and iShares ETFs have been chosen for comparison purposes (Chart 1):

As can be seen in Chart 2 below, the average F-Class mutual fund failed to beat the 5-year annualized returns of their respective benchmark index or iShares ETF in all fund categories, as of November 30, 2010 (Note:  returns shown do not take survivorship bias into consideration, so the average F-Class mutual fund returns are most likely overstated).

The percentage of individual F-Class mutual funds that outperformed their benchmark index in the Canadian Equity, U.S. Equity, and International Equity categories were 21.1%, 44.1%, and 35.0% respectively, as of November 30, 2010 (Chart 3) – much higher than past Standard & Poor’s quarterly SPIVA reports (Note:  Standard & Poor’s Indices versus Active Funds  Q1 2010 Canada Scorecard showed the percentage of mutual funds that outperformed their benchmark index over 5 years to be 3.3%, 9.7%, and 9.8% respectively). This should be expected, since the F-Class series have lower management expense ratios (MERs) compared to their A-Class counterparts.

Even though the results in favour of passive management are not as dramatic as those seen in past SPIVA reports, it should be noted that there has still been outperformance by the passive indices and ETFs. For an iShares “Global Couch Potato” portfolio (similar to the one discussed on, the outperformance over 5 years would have been approximately 0.60% annualized, as of November 30, 2010, compared to a similar portfolio using equally weighted F-Class funds in each category.  In the case of the do-it-yourself (DIY) investor, the benefit of passive investing over active investing is clearly illustrated. For the average client who is deciding on whether to use a fee-based passive advisor compared to an active advisor who is paid through trailing commissions (assuming a typical balanced global portfolio with a trailing commission of 1.00%), the benefit of using passive management would most likely diminish as the management fees charged by the fee-based passive advisor exceeded 1.60% (although this does not take into consideration many other benefits of passive management, such as transparency, tax-efficiency, and broad-based diversification).

Sources: Morningstar PALTrak, Standard & Poor’s, MSCI, Bank of Canada, Bloomberg


By: Justin Bender | 0 comments

RBC Managed Payout Solutions

Take your payout. Protect your wealth... potentially.

Retirement income distribution is on the minds of many investors and advisors alike. Various products have been introduced to help aid in the transition from an accumulating portfolio to one of income generation and tax-efficient distribution. A product that has received a number of questions from clients is the RBC Managed Payout Solution, as well as the Enhanced and Enhanced Plus versions of the same fund. It appears that no matter how RBC phrases its marketing message, clients are still under the impression that RBC Managed Payout Solutions are offering a generous 5%, 6%, or even 7% guaranteed income (if only this were true). RBC’s offer is in fact a non-guaranteed monthly payout, with no guarantee whatsoever of investment returns. The actual dollar value of the monthly payouts can fluctuate significantly year-to-year, making any cash flow planning futile. No inflation increases are built into the payout calculation, so unless a client receives very generous market returns, inflation will erode the purchasing power of their monthly payouts.

In RBC’s simplified prospectus, the following investment objective of the funds is included:
“...provide relatively tax efficient distributions...without continuing significant erosion of the net asset value of the fund.”

By examining a hypothetical investment of $100,000 in each of the funds on December 31, 2004, it appears that all of them have experienced erosion of the net asset value of the fund over a 5-year investment horizon, ranging from $8,333 to $18,841 (see graphs below). Although the negative events of this particular period were a key contributor to this net asset value erosion, I couldn’t imagine an aggressive 7% withdrawal rate not adding to the depletion. 

In 1997, William P. Bengen published a series of articles in the Journal of Financial Planning titled, “Conserving Client Portfolios During Retirement,” in which he determines a safe maximum withdrawal rate that has historically resulted in a 30-year portfolio longevity, regardless of the year of retirement. Bengen determines this rate to be approximately 4.15% of the original market value for a typical balanced portfolio, increasing with inflation each year. I would be much more comfortable with a product that distributed tax efficient cash flow at this rate, although I admit, its features would not look as appealing on a glossy marketing brochure.

By: Justin Bender | 6 comments