Only a few actively managed funds are beating the indexes

KEITH DAMSELL

Score another one for exchange-traded funds. A look at the short-term returns of the country's largest Canadian equity funds and their corresponding indexes indicates the bulk of actively managed funds come up short when it comes to performance.

ETFs -- and Barclays Global Investors Canada Ltd. in particular -- are a force to be reckoned with. The money manager's 16 funds now control about $13.3-billion, up from about $3-billion in 2002. Supporters claim passively managed ETFs are cheaper, more tax efficient and, most important, consistently post superior returns.

Active managers -- that is, the lion's share of the traditional mutual fund industry -- have been watching the rise of the ETF with some skepticism. They contend that passive funds capture all of the upside in a bull market but are losers when markets turn south and are less equipped to handle the downside. In theory, active managers can sell the bear market dogs and keep the winners, while passive funds are stuck with the lot.

This year offers a litmus test of the theory. The S&P/TSX composite index has given investors a wild ride this year, up 10.8 per cent in April, down 3.3 per cent in June and, as of Friday, up 6.6 per cent year to date. In other words, a perfect choppy climate for active managers to excel.

Well, not exactly. Only three of Canada's 10 largest equity-dominated funds consistently beat their corresponding index's returns across one, three and six-month periods ended July 31. All three are Canadian income balanced funds, with very different asset mixes when it comes to stocks, bonds and geographic composition:

CI Signature High Income Fund. The $4.4-billion fund trumped the returns of its income balanced benchmark, a blend consisting of 60 per cent of the returns of the S&P/TSX Total Return and 40 per cent the Scotia Universe Total Bond Return index. The fund, managed by well-regarded Eric Bushell and Matt Shandro, has a hefty weighting in income trusts and holds about 60 per cent of its assets in Canada.

CIBC Monthly Income Fund. Arguably the best fund in the bank's mediocre stable. Like CI Signature, it consistently beat the income-balanced blended index. The $5.9-billion fund managed by Stephen Gerring has an 83.4-per-cent asset weighting in Canada.

RBC Monthly Income. In contrast to the CI and CIBC funds, RBC's $8.4-billion fund has a significant 44-per-cent weighting in bonds. Buoyant financial, energy, mining and material equities make up about 39 per cent of holdings.

Fees are important. The top three income balanced funds have an average annual management expense ratio (MER) of 1.37 per cent. In contrast, megafunds with higher management fees were consistently beaten by their corresponding index. The Investors Dividend Fund, Canada's largest mutual fund with $11.8-billion in assets, has an MER of 2.76 per cent, and has trumped the short and long-term returns of the corresponding S&P/TSX 60 only once, losing 1.72 per cent for the three months ending July 31 compared with the index's 2.11-per-cent loss.

Similarly, the $8.2-billion RBC Balanced Fund has a MER of 2.28 per cent, yet has never beaten the short or long-term returns of its corresponding blended balanced income index.

The conclusion of all the data-crunching?

Only a slim number of funds can consistently beat the index. Most important, a great fund is a consistent outperformer, regardless of the time frame. The top three short-term performing funds -- CI Signature High Income, CIBC Monthly Income and RBC Monthly Income -- have stellar long-term track records too, consistently matching or, in most cases, beating the corresponding index across one, three and five years. Advisers starting to wrap it up

Wraps are on the rise. A study released Aug. 15 by Vancouver's Credo Consulting Inc. found that 37 per cent of financial advisers have some clients invested in portfolio solutions, so-called "wrap" accounts that bundle together mutual funds. That's up from about 29 per cent of advisers using wraps in 2004.

In addition, the use of wraps is expected to rise, with 73 per cent of advisers who are now using wraps planning to increase their clients' exposure to the product. At present, advisers that use wrap products have an average of 22 per cent of clients' funds in the investment structures. Credo conducted the study of 1,500 advisers in partnership with the Financial Planners Standards Council.

The data supports a 2005 forecast from Investor Economics. The Toronto financial services consulting firm predicts wraps will account for about 43 per cent of the investment fund market by 2013, up from 22.6 per cent in 2004.

Keith Damsell is editor of GlobeinvestorGOLD.