The Average Actively Managed Fund Must Underperform the Index

In last Saturday’s Globe & Mail (finally got around to reading the paper today), Rob Carrick compared the performance of Canadian equity funds to a low-cost index ETF that covers the entire Canadian market, iShares CDN Composite Index Fund ETF (XIC). It is the one I own to capture the Canadian market and it makes up the entire Candian equity portion of my portfolio. He went five years back because the ETF has not been around for 10-years yet. He compared this ETF to the “100 or so funds in the Canadian equity category that have been around for the five years to Sept. 30.” Surprise, surprise, only 5 mutual funds beat the index over that period. Here are some of those funds, sorted by 5-yr % return:

Fund name MER 5-yr % return 5-yr beta
Acuity All Cap 30 Canadian Equity 2.85 27.96 1.385346
imaxx Canadian Equity Growth 2.76 24.54 0.986167
Altafund Investment Corp. 2.72 22.02 1.042311
TD Canadian Equity 2.09 21.39 1.145336
iShares CDN LargeCap 60 Index 0.15 21.39 0.980728
TD Canadian Equity-A 2.09 21.09 1.130500
iShares CDN Composite Index 0.25 20.94 1.002607
Desjardins Environment 2.35 20.71 0.985526
OTG Diversified 1.30 20.51 0.981718
Altamira Precision Cdn Index 0.53 20.45 0.983078
iShares CDN MidCap Index 0.55 20.45 0.983592
Hartford Canadian Stock D 1.88 20.43 0.949451
Integra Canadian Value Growth 2.24 20.04 0.906116
TD Canadian Index – e 0.31 19.93 0.987276
National Bank Canadian Index 1.14 19.84 0.983619
Leith Wheeler Canadian Equity B 1.50 19.72 0.720842
Ferique Equity 0.66 19.58 0.964336
Manulife Sector Rotation Fund 2.69 19.55 1.012749
RBC Canadian Index 0.71 19.55 0.996493
GGOF Canadian Lrg Cap Equ Mutual 2.39 19.54 0.878637
Hartford Canadian Stock B 2.60 19.53 0.952128
Acuity Social Values Canadian Equ 2.85 19.52 1.178193
Sceptre Canadian Equity – A 1.69 19.42 0.939199
TD Canadian Index 0.85 19.41 0.997669
FMOQ Canadian Equity 0.95 19.34 0.933744
CIBC Canadian Index 0.97 19.30 0.995622
Scotia Canadian Stock Index 1.03 19.20 0.997593
BMO Equity Index 1.01 19.12 0.994472
PH&N Canadian Equity-A 1.13 19.09 0.870502
Fidelity Cdn Disciplined Equity-B 2.24 18.98 1.019771
Fidelity Cdn Disciplined Equity-A 2.45 18.85 1.021164
Meritas Jantzi Social Index 1.94 18.81 0.872850
PH&N Community Values Cdn Equ-A 1.39 18.65 0.815829
Fidelity Cdn Disciplined Equ Cl-B 2.30 18.65 1.019219
Fidelity Cdn Disciplined Equ Class 2.50 18.52 1.020240
Manulife Canadian Equity Fund – A 2.23 18.38 1.046150
OTG Growth 1.30 18.37 0.933543
Supposedly
60+ more funds to go on this list…

Note that some funds that started 5 years ago probably got canned due to poor results (or other reasons) and are thus excluded from the “100 or so equity funds” that Carrick mentions. See Survivorship Bias.

These results should come as no shock to anyone. If it does surprise/shock you, I recommend reading A Random Walk Down Wall Street as Burton Malkiel explains the reasons why index funds do much better far better than I can. You don’t even have to believe in efficient-market theory. According to Malkiel (and others of course):

But even if markets were not efficient, indexing would still be a very useful investment strategy. Since all the stocks in the market must be owned by someone, it follows that all the investors in the market will earn, on average, the market return. The index fund achieves the market return with minimal expenses. The average actively managed fund incurs an expense ratio of about 1.5 percent per year [ed: in Canada I think this is higher]. Thus the average actively managed fund must underperform the market as a whole by the amount of the expenses that are deducted from the gross return achieved.

The only way mutual funds will do you any good is if you can predict beforehand which mutual funds will be one of the handful that do outperform the indexes (good luck). He goes on mention that this claim is actually borne out in the data from the US market in the past 20 or so years,

Between 1974 and 2006, for example, the S&P 500 outperformed more than three-quarters of the public equity mutual funds–the average annual total return for the S&P 500 was more than 1.5 percentage points better than that of the media fund

Again survivorship bias plays a role here. If we included some of the funds that existed in 1974 but did not make it to 2006, the S&P 500 would most likely have outperformed an even larger fraction of the public equity mutual funds from 1974 to 2006.

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7 Responses to “The Average Actively Managed Fund Must Underperform the Index”


  • It is amazing to me that so many people continue to pour money into mutual funds. That is what I invest in companies like IGM Financial – I get the benefit of the MER’s through my dividends and share appreciation.

    Good post.

    The Dividend Guy

  • Wow. You would think that XIC would be in the middle of that list given that it replicates the TSX. If Canadian equity funds set the TSX as their bench mark, one would think that on average they would meet that benchmark (with half of them below/above the benchmark). I’m surprised that only 5 beat XIC. Those stats are a little embarrassing for the mutual fund industry.

    Y HAT

  • Y Hat, you are perfectly right that XIC would be in the middle of that list if we looked at pre-MER returns. But these returns are the returns are the returns actually seen by investor so they include MERs (ie. they are annualized percentage change in the NAV).

  • The Dividend Guy, there is a lot of merit to your strategy of buying stocks (dividend paying stocks or not) on the basis of low costs. As long as your turnover is low and you don’t spend too much on commissions your annual expenses could theoretically be lower than the average ETF, thus maximizing returns.

  • Dave,

    You’re right. I didn’t consider the MER.

  • And look at the Beta of the 5 active funds that beat the index — all took on more risk than the index fund.

  • Good point Bill, I don’t think I had noticed that.

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