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Mutual Funds – Performance Caution by Peter Dolezal The siren song of mutual funds has long attracted a multitude of investors. Despite a Management Expense Ratio (MER) averaging 2.45% annually, Canadians have invested many billions of dollars among the more than 3,500 available Canadian funds. Sales pitches for mutual funds suggest that the high Peter Dolezal, Retired Financial annual holding cost is worth Consultant & Author the prospect of significantly higher returns than are achievable through other options such as Exchange-Traded Funds (ETFs) or Index Funds, which charge much less, but seek merely to track rather than beat comparable indexes.
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SEASIDE TIMES | JULY 2012
Standard & Poor’s 2011 Indexes Versus Active Funds Scorecard (SPIVA) reported that in 2010, “only 19.6% of Canadian Equity active funds were able to outperform the S&P/TSX Composite Index.” The Report went on to conclude that over longer time frames of three- to five-year periods, the performance worsened, with only 11% and 2.5% respectively outperforming the Index. This dismal performance is quite understandable. To achieve even break-even performance with passive funds such as ETFs and Index Funds, equity mutual funds must outperform the Index by at least the 2% cost premium they charge. For the five-year period ending in 2010, the TSX Index delivered an average compound annual return of 3.8%. To improve on this return by two percentage points, a mutual fund would have needed to deliver an average annual return more than 50% greater than the Index. As actual performance clearly indicates, this is a virtually impossible expectation, especially over longer time frames. Mutual funds may have a niche role in some portfolios. The investor, however, should be aware that compared to much lower-cost ETFs or Index Funds, many mutual funds start out with a handicap of roughly 2% annually. As years of actual comparative performance demonstrate, this handicap – to the mutual fund investor’s detriment – is rarely overcome. A retired corporate executive, enjoying postretirement as a financial consultant, Peter Dolezal is the author of three books, including his most recent, The SMART CANADIAN WEALTH-BUILDER.