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S&P research on active managers suggests investors should pick equity mutual funds carefully

by Wayne Cheveldayoff, 2004-12-16

Standard & Poor’s recently published a report showing that only about a third of actively managed Canadian equity mutual funds have outperformed the S&P/TSX Composite Index over a five-year period.

With such a poor showing by active managers, investors need to be especially careful in choosing equity mutual funds for their retirement portfolios.

While S&P has published such statistical comparisons of active funds versus their respective indices in the U.S. for some time, this is the first time it has published such data for Canada and it intends to release updates on a quarterly basis.

The findings point to the importance of identifying the better-performing active managers. In the year ended September 30, 2004, only 17.5 per cent of actively managed Canadian equity mutual funds did better than the S&P/TSX Composite Index’s total return (including dividends). Put another way, 82.5 per cent of active managers generated lower returns than the index.

Over three years, only 16.4 per cent of active managers outperformed the index, while for five years the number was 35.4 per cent.

With respect to the actual returns, actively managed Canadian equity mutual funds recorded an average return of 15.54 per cent over one year (versus 18.85 per cent for the index), 7.48 per cent annually over three years (versus 10.19 per cent for the index) and 6.06 per cent annually over five years (versus 6.2 per cent for the index).

S&P’s research is likely to spur more debate in the investment industry over whether index funds are better for investors than actively managed funds.

S&P says it is presenting its research, known as the Standard & Poor’s Indices Versus Active Funds (SPIVA) Scorecard, as part of its commitment to providing Canadian investors with the information they need to make more informed investment decisions.

S&P can be considered a neutral third party since it doesn’t offer mutual funds, although it does licence its indices for use by index-linked mutual and exchange-traded funds.

SPIVA scorecards are unique and more advanced than other analysis in several respects. For example, they correct for survivorship bias – an important feature since around one in four funds has merged or was liquidated in the past five years. They also provide an “apples-to-apples” comparison of a fund’s return versus that of its appropriate category benchmark and include both equal and asset-weighted average returns (in this case, showing fairly similar results).

For investors wanting to take advantage of the apparent better performance of indices, there is plenty to choose from.

Most banks have low-fee index-linked equity funds. (Although S&P did not address the question, fees may be responsible for much of the actively managed underperformance since most actively managed funds charge annual management fees of around 2.5 per cent.)

In addition to index-linked mutual funds, there are several exchange-traded funds (ETFs) that seek to replicate the TSX indices. TD offers the TD S&P/TSX Composite ETF, along with a capped version and growth and value versions.

Barclays Global also offers a Canadian equity ETF, although its iUnits S&P/TSX 60 only includes the largest 60 stocks (versus more than 200 in the composite index).

In structuring their portfolios, investors may want to make use of the index-linked alternatives for some of their equity exposure but not all. They should also reserve some room for top-performing actively managed funds, hedge funds and specialized funds, such as for biotech or technology where index-linked choices are few or don’t exist.

In presenting its research, S&P noted that actively managed small-cap funds had a much better record recently, with 71.4 per cent of actively managed Canadian small-cap funds beating the S&P/TSX SmallCap Index. However, over three and five-year periods, only about 35 per cent of the active small-cap managers did better than the index.

Investors can access the full S&P report for no charge at

Wayne Cheveldayoff is a former investment advisor and professional financial planner. He is currently specializing in financial communications and investor relations at Wertheim + Co. in Toronto. His columns are archived at and he can be contacted at

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©2004 Wayne Cheveldayoff