Score One For Active Management? Check Out These Index Beating Funds
The top mutual funds have trounced the Canadian index this year, which again opens up the debate of whether active management can outperform a passively managed portfolio after fees. Fans of passive investing say it’s nearly impossible to beat the market over the long term, and equally as difficult to pick the investments that will outperform in the future.
Related: Market efficiency – A glaring oversight in passive strategies
Past performance doesn’t guarantee future results, and much research shows that the mutual funds which performed best in the past have tended to under-perform in the following years, eventually reverting back to the mean. Couple that with mutual fund fees that are among the highest in the world and you can see why most investors are better off taking a passive approach with low cost index funds and broad market ETFs.
Market beating funds do exist, but you’re not likely to find one among your banks’ list of funds. Instead, some of the top mutual funds are managed by large, private investment firms like Mawer, Beutel Goodman & Company, Steadyhand, and Leith Wheeler.
I went to Morningstar to find mutual funds with a track record of beating the index. After sorting through 775 Canadian equity funds, including 70 that have been rated five-star funds by Morningstar, I settled on these three mutual funds that have topped the Canadian index over the last decade.
Index beating mutual funds
| Year | Beutel Goodman | Mawer | Leith Wheeler | ishares XIU |
| 10-year return | 8.91 | 10.70 | 9.41 | 8.22 |
| 5-year return | 12.78 | 15.20 | 12.87 | 8.23 |
| 2013 (YTD) | 21.66 | 22.77 | 19.55 | 10.21 |
| 2012 | 10.77 | 12.67 | 13.61 | 7.87 |
| 2011 | -6.99 | 1.90 | -6.24 | -9.23 |
| 2010 | 15.52 | 13.74 | 15.42 | 13.60 |
| 2009 | 24.11 | 29.45 | 27.54 | 31.50 |
| 2008 | -22.87 | -29.68 | -32.87 | -31.08 |
| 2007 | 5.27 | 11.50 | 8.87 | 10.93 |
| 2006 | 15.12 | 13.94 | 17.55 | 18.93 |
| 2005 | 16.18 | 20.60 | 19.35 | 25.94 |
The mutual funds were compared with XIU, the iShares Canadian equity ETF with a MER of just 0.15 percent. I used the ETF because you can’t actually buy the index, but you can buy a fund or an ETF that tracks it.
Related: Dividend aristocrats and iShares CDZ
All three funds have handily beaten the index this year, with two of the three funds more than doubling the index. They’ve also shown staying power by outperforming the index over the last 10 years. Mawer’s fund has been the most impressive, outperforming XIU by a healthy 2.5 percent after fees.
About the funds
Beutel Goodman Canadian equity fund invests in established Canadian companies, typically holding between 35 and 45 stocks. The fund has a MER of 1.36 percent and manages over $4 billion in assets. You’ll need to invest a minimum of $5,000 to start, and additional contributions can be made for as low as $100.
Leith Wheeler Canadian equity fund uses a strong value bias to pick its investments, meaning it tends to include companies in its portfolio that are currently out of favour. The fund has a MER of 1.57 percent and manages $1.7 billion in assets. Minimum investment is $25,000 directly through Leith Wheeler, or $5,000 through a registered dealer. Subsequent contributions can be made for a minimum of $1,000.
Mawer Canadian equity fund seeks above average, long term, risk adjusted returns from a portfolio of mid-large cap Canadian stocks. The fund has a MER of 1.21 percent and manages nearly $1.5 billion in assets. Minimum investment is $5,000 per fund, per account.
Final thoughts
Mutual fund companies are quick to point out when their funds outperform, but the fact is the vast majority can’t do it consistently and over the long term. I’ve identified three funds out of a possible 775 that have managed to beat the S&P/TSX 60 Canadian index over the last 10 years. There was no way to tell which ones would outperform back then, just as we can’t tell if these ones will continue to beat the index in the future.
Related: Are mutual funds really that bad?
But the two distinguishing traits that give these index beating funds a good chance to succeed in the future are their relatively low costs (between 1.21 and 1.57 percent) and their simple investment strategies that minimize turnover and emphasize large, blue chip companies.
Passive investors may have taken their quest too far in admonishing all actively managed strategies. I’ll give credit where credit is due and acknowledge that there are well managed mutual funds available that can consistently beat the index and that don’t charge outrageous fees to do so.
Flip the coin enough times and three or so out of 775 will come up heads for ten straight years right?
I just looked up B.G. and over the last 20 years it has outperformed by .5% or so, much less impressive.
Care to make a friendly wager on what the returns of these funds will be for the next 10 years? Morningstar 5-star funds don’t have a great track record…
@Kyle – So it has outperformed for 20 years, not just 10? Man, it takes a lot to impress you 🙂
Some passive investors would run through a brick wall to shave 0.5% per year off the cost of their funds. Why is 0.5% out-performance something to scoff at?
Even long streaks of outperformance are no guarantee that it will continue. One just needs to look at Bill Miller, for example. The standard warning “Past performance is no guarantee of future results” is there for a reason.
I’ve also noticed that each of the funds above had periods of under-performance. So, how long would an individual investor hold on to an underperforming fund before selling it? Investors are notorious for not earning fund returns. And to get those index beating returns one would need to stick with the fund through the good and the bad years.
Also, shaving 0.5% per year off the costs is guaranteed to increase return by as much. Is 0.5% outperformance over the last 20 years a guarantee of outperformance over the next 10 or 20 years?
And I wholeheartedly agree with this part of your article:
“There was no way to tell which ones would outperform back then, just as we can’t tell if these ones will continue to beat the index in the future.”
So the bottom line? Buy low-cost index funds. And that’s the advice of Warren Buffett.
http://www.reuters.com/article/2007/05/07/berkshire-indexfunds-idUSN0628419820070507
I was just about to say the same thing. Let’s check back 10 years from now and see which one does better…. It’s almost impossible to beat a low cost index fund over the long run 🙂
Solid points Rob. So I’ll go back to an article I wrote, if you truly believe in active-management, why settle for anything less than the best? Just buy BRK stock instead of paying mutual fund fees. His record is even more impressive than the ones you mentioned.
I think people might be sorely disappointed in BRK if they are looking for big outperformance, or outperformance at all.
BRK has a lot of cash. To outperform, it’s going to need to be able to deploy at lower stock prices. Frequent stock market crashes would be the best thing ever for Berkshire.
It has a unique problem: it’s too good of a business. Even Buffett admits that given its size, outperforming the broad market will be very, very hard going forward.
I’d take a small cap value fund over Berkshire, but that’s just me. More volatile, sure, but over periods spanning decades, small cap value funds will likely outperform, just as they have through history. And, at the end of the day, the small cap value managers out there are Buffett believers using the same methodology — bottom-up, old-school stock picking.
Not to mention one share in BRK.A goes for $174,500!
That’s why they’ve created BRK.B trading at about $116.36 today. 😉
I wonder what will happen with BRK when eventually Mr. Buffett exists the scene…
Careful about just buying BRK….
http://www.cbsnews.com/8301-34227_162-57610666/why-not-just-buy-stock-in-berkshire-hathaway/
http://www.cbsnews.com/8301-505123_162-57610851/dont-put-all-your-eggs-in-warren-buffetts-basket/
1. I love that you used an index ETF as the benchmark instead of the S&P/TSX 60.
2. I think you picked out the most relevant attributes handily. It IS possible to outperform the market, even by “only” 0.5%…if the fees you’re paying are negligible. If so, then passive investing is a harder sell.
3. However (of course) the fees AREN’T negligible in most cases. 1.57% looks like a deal when you compare it to the much more common 2.65% (for a closet-indexing, underperforming retail bank fund), but it’s still a full percent of consistent returns that have to be made to compensate.
Good post, Mr. Engen. No goats were fed in the writing 🙂
@Sandi – The real enemy is the index-hugging mutual fund that the banks pass off as Canadian equity and charge 2+ percent MER to unsuspecting customers.
At least these three funds differentiate themselves from the index so they at least have a fighting chance. You’re right about overcoming the costs and that fund managers are down a touchdown before the kick-off.
Egg-sactly. I think you gave fair credit where fair credit is due. Foaming at the mouth that NO-ONE can EVER beat the market kind of detracts from the passive cased. That’s a lot, coming from me.
@Sandi: I don’t think anyone says that no-one can ever beat the market (Warren Buffet certainly does), but the point is that it is not possible to identify that person (fund) in advance, and then when someone (fund) does beat the market in the short term, as some certainly will do, there is no evidence of persistence of outperformance over the long term.
You’re preaching to the choir, Grant 🙂
Anyone wish to guarantee that these three funds will outperform for the next 10 years? If so, I’m in. Give me the name of the financial advisor who will guarantee that my investment will at least match the XIU over the next decade (net of their take). Of course XIU guarantees that. I really don’t care what happened over the last 10 or 20 years. The informational content of that is at best worthless.
Good post, Rob, and nice that you give credit where credit is due. However, as you say, it’s not possible to pick who the few long term winners will be in advance, and there is no evidence of persistence of performance beyond the randomly expected, so it doesn’t make sense to choose actively managed funds.
Unfortunately, as this particular year there are many outperforming actively managed funds, there will be lots of advertisements boasting these short term results to try and lure people away from evidence based investing.
There is no debate about whether active management beats passive indexing. The evidence in the financial literature is very clear in favour of indexing. People either don’t know about the evidence, or just choose to take a punt on a particular money manager, anyway.
I get into a number of arguments about “active” vs. “passive” investing strategies all the time, but at the end of the day, I love knowing that I am investing my money with someone who is a) looking out for it daily b) trying to beat the index and c) making conscious choices on a daily basis where my money is concerned.
Those 3 attributes could fully apply to a 10-year old. I hope you’re more selective than that 🙂
I agree with paying someone to look after your money, if you choose not to do it yourself, but not to try to beat the index. Why pay someone to try and do something that has been proven by many studies not to be possible over the long term?
In today’s timely article Carl Richards (aka the Sketch Guy) says that it’s because “Despite the evidence, we still like to go with our gut.”
http://www.nytimes.com/2013/11/18/your-money/arguments-for-trusting-the-data.html
Very good article. It’s also about marketing. The investment industry spends huge amounts of money trying to convince people they can beat the market, so they can charge the high active management fees. The result is a huge transfer of wealth from those who own it to those who manage it.
Rob, would you consider buying any of these funds? Their returns look impressive, especially mawer – a ten year return of 10.7%? Yes please
@Michael – I’d say my investing strategy is similar to these funds in that I look for large, blue-chip companies that are value priced and invest for the long term. While the passive investing camp will chastise that approach (individual stock picking), at least I can say I’m saving the annual fees by managing my own portfolio.
I’ve heard nothing but good things about Mawer funds and would definitely give them a closer look if I didn’t want to manage my own portfolio.
Rob, do you have any plans to write a post with updated performance figures for the portfolio?
@igra – For mine? Absolutely. I’ll do one at the end of the year and compare to CDZ and XIU.
Awesome! Thanks, Robb!
I don’t like MF, but I’m really impressed by MAW106 performance … I noticed this fund about 2-2.5 years ago (actually my cousin invest heavily into it and was pointing me on this on), and was thinking to invest some $$$, however, I was thinking that “Past performance doesn’t guarantee future results” and maybe XIU or TDB900 will outperform it, so I didn’t buy MAW106… Now, I see again that MAW106 continue to outperform index by huge numbers….
It’s funny how your cousin wasn’t pointing to that fund back in 2005 and 2006 when it underperformed XIU by “huge numbers”… 🙂
Browne’s Permanent Portfolio:
10-yr = 9.4%
Average of ‘Best’ Funds:
10-yr = 9.7%
The 10-yr average of the stock portion of the PP is 9.7% (or 2.4% of total portfolio return).
Makes you wonder why anyone would dedicate more than 25% of their investable assets to stocks, let alone pay a fund manager to “beat the market”.
10-yr Return (03-current, C$)
Gold: 15%
Silver: 20%
2014 returns are in:
Beutel Goodman Canadian Equity Class D – 10.26%
Mawer Canadian Equity A – 15.83%
Leith Wheeler Canadian Equity Series B – 7.32%
XIU (NAV) – 12.04%
Only Mawer managed to outperform last year and Leith Wheeler under-performed badly…
It’s true that Mawer outperformed the broad market, but that was not due to skill, it was due to taking more risk with exposure to value stocks as described in a recent post by Justin Bender.
http://www.canadianportfoliomanagerblog.com/active-funds-exposed/
Similar results can be achieved, more cheaply, by adding value ETFs to your portfolio.
I disagree, Grant. I think *better* results can be achieved with a value tilt using low-cost ETF. 😎 And it’s excellent analysis by Justin Bender!
What I wanted to say by posting those returns is that if someone had bought one of those funds last year after seeing their past track record, they would have been disappointed in two cases out of three. And good luck to anyone who attempts to predict the outperforming one for this year!
Indeed, you are right, due to lower MERs of index ETFs and no active management risk.
It’s been a little over 8 years since the post… Many things have changed but one didn’t. 🙂 All three funds went on to underperform the index (as proxied by XIU) since the article was written.
Results for last 1, 3 and 5 years lag that of XIU for all three funds.
We shouldn’t be surprised really as this is a common story.