If you pay taxes - buy index funds
There's been lots of rumbling in the Fund Library in the last few weeks that managed funds are inherently dogs related to the index. Most of the angst has been over the apparent inability of managers to overcome the MER. Well, I'm raising the bar. For taxable investors, management must also overcome the increased taxes they trigger relative to an index.
I've spent some intimate time with Paltrak's (30-Sep) 5yr tax efficiency ratios and here's what I've calculated:
5 year Tax Efficiency (TE)1
The bottom line is that most investors will require a managed fund to beat the index by about 1% to break even after taxes. This is an annual 1%; after 20 years it compounds to 22%. Incidentally, I repeated the calculations for US funds against a US index and got similar results (marginally less significant due to loss of dividend tax credit). Unlike MER's which can be reduced through competition, the negative tax efficiency effect is inherent in management.
The average canadian diversified equity fund returned 16.47% during the same 5 year period: just enough. However, a number of studies (cited on other threads) have more scientifically established that in the long term funds do not beat an appropriate index (there were a few small caps represented in my data). The average top quartile fund returned 21%, but if the manager can't pick the right stocks then why should I or an FP be able to pick the right funds. And if I switch funds, my tax efficiency gets much worse and the bar is raised again.
Now an honest admission: despite all this data, I still have a hard time believing that fund management is not worthwhile. If everyone bought the index, what would happen to the competitive factors that are the basis of our capitalist system? Fund management should work; why doesn't it?
I'm 90% convinced to go with the index.
Randy,you had to work with the GL Can. Index Fund because it is the only one reported by Paltrak,but isn't the hurdle much higher for managed funds if you use TIPS with an MER of 0% vs. GL Can. Index with an MER of 1.10%?
Thanks for the analysis. Have a look also at Vanguard's Updated Estimates Of Year-End Capital Gains Distributions. Notice how little the index funds pay out at year end and how much unrealised gains they're sitting on.
"If everyone bought the index, what would happen to the competitive factors that are the basis of our capitalist system?"
The reason why index funds "work" is because of all those active managers out there who are keeping the market efficient. As either Bernstein or Armstrong point out, these managers' efforts represent a "free lunch" for index investors :o)
Rick - You're correct that the bar would be raised if you invest directly in the index. The Greenline returns are already net of MER and the argument that management does not recover the MER has been made elsewhere; my results are in addition.
The return of the TSE 100 over the same period was 18.6%. I don't have access to tax effciency (TE) numbers for the index (which is why I didn't use it), but if one applies the TE of GL Cdn Index Fund the returns to beat would be:
However, my guess is that the TE of the true index would be slightly less than GL's index because without the management fee, dividends would make up a larger portion of your net return. So, the "bar" is likely a tenth or two of a percent lower than my calculated results: big deal.
Bylo - Maybe I've just been brainwashed, but somehow the efficient market hypothesis is hard to believe. But in the long haul, I suppose there is some minimal management (if belated) even with maintaining the composition of the index.
Vanguard's unrealised gains on their index funds are huge! It's interesting to consider whether they would be distributed if the company folds (remote possibility, but I could be looking at a 50+ year hold - a lot can happen). My understanding of TIPS and HIPS is still limited, but I would guess they do not carry the same risk. Is this correct?
I'm 95% convinced to buy the index.
compelling arguments backed up by sound research. Reality is that most Fund holders by nature of their diversification actually start to mimic the index but with much higher MER's. Either the Post or Globe, think it was post, had good section on MER's adding further support to your argument. Would hope jurgen et al would jump in here, their experiance could be intersting.
Missing from the discussion is the fact that the risk profile of a managed account can be considerably different than the index. So the return achieved by a money manager on a risk adjusted basis may be a better deal, even if the absolute return is the same or lower. This is the belief system that is in place at many Professional Investment Counselling Firms.
2 cents worth.
Randy,TIPS and HIPS are units of two separate trusts created by the TSE.
You can get detailed information,including the prospectus and the latest audited financial statements for each,by phoning Patrick McDonagh at the TSE---tel:(416)947-4581;fax(416)947-4272.
Quite frankly,I don't know why anyone would buy an index fund such as TDGL Can. Index Fund with an MER of 1.10%,when they can buy TIPS or HIPS with MER's of 0%.I quess it's the old story that mutual funds are sold....not bought.
In the US,the MER of S&P500 SPDR's is virtually the same as the MER for Vanguard's S&P500 Index Fund---0.185% vs. 0.20%,respectively.
RSC - Good point about needing to look at risk adjusted returns. It deserves more consideration than I'm about to give it, but here's a quick look at 5 year standard deviations:
Incidentally the range for Cdn Diversified funds was 7.9 to 34.2.
On the surface, it doesn't look like a convincing argument. But to go further, I'll need some help selecting the best data to use for risk adjusted returns.
Rick - thanks
Concerning the concept of risk as it applies to index funds vs. managed funds:
In my opinion, the more precisely an investor can identify what she holds in her portfolio at any given time, the easier it is to manage risk given one's risk tolerance, goals, etc. With index funds, you know what you get: a low MER vehicle that mimics the return of a given stock index and is fully invested at all times. Armed with this knowledge, I would think that an investor (or her financial planner) should be able to do a much more accurate job in allocating one's investments across the various asset classes given the investor's profile.
Contrast this with an individual who uses equity mutual funds. If the MER is higher than the comparable index fund, there is automatically an increased risk that the fund could underperform the index fund over the long term. Secondly, there's the risk of the fund manager 'upsetting' your asset allocation plan by taking actions that cause the fund's portfolio composition to differ markedly from its state when you bought it, such as building up a high level of cash reserves or intentionally/unintentionally overweighting a given sector by a significant amount. I consider such uncertainty to add an element of risk: the risk of holding a portfolio that at some point may represent an asset mix significantly different from that which you desire, even though the instruments you hold in it (GICs, T-Biils, Bonds, mutual funds) have not changed.
At least with an index fund, or fund whose manager is committed to remain fully invested (ie, with the usual 5-10% cash float for redemptions, etc.), you know what you're getting for your money and can plan accordingly, which I consider to be synonymous with LESS risk, not more.
Colt, good points.
Here's one more. I read an article a while back that looked at the compositions of US bond funds. The conclusion was that managers of high-MER bond funds were buying longer bonds and/or buying lower grade bonds (i.e. taking more risks) than their low-MER brethern¹. Presumably this was in order to offset their MER handicap.
Yup, costs do matter. Sometimes it's better to get what you don't pay for.
¹what's the feminine of "brethern"?
Two points 1. buying TIPS you will have to pay a brokerage commission, with a discount broker maybe as low as $29/ purchase. 2. what MER would SPDRs have ? Again commission costs.
Good reading on Index funds and why and the fact 95% of actively managed funds fail to beat the market is 1. Berton MALKIEL "RANDOM WALK DOWN WALL STREET" 2. Peter BERNSTEIN " CAPITAL IDEAS".
Good points. I have always been troubled by the fact that most Asset Allocation models use historical index returns and data as the basis for their risk/reward analysis but then use actively managed pools for their clients dollars. And so I agree with you here. It can be riskier if you are not getting what you believe you were buying.
My point had more to do with whether or not a professional money manager can disproportionatly remove risk (relative to performance ) from an all equity account by way of security selection.
Most believe they can. So even though many of them know in their hearts that their performance is not likely to beat the index over meaningful periods of time, they believe that they add value by reducing risk/volatility.
As an aside I think if you lokked at the composition of most pooled funds (ie. funds used in the asset allocation programs of professional money managers) you would see that they are typically fully invested so as to avoid the point you made about money managers " upsetting " the allocation model with their own view of the world.
Your points are well taken though.
TIPS mimick the TSE 35 right? Is the TSE 35 calculated without dividends? If this is the case then TIPS will not match the TSE 300 index, but will match the TSE 300 less dividends. (or approximately so) Given that the average dividend yield is around 3%, it would seem to me that TIPS, therefore, has a MER of around 3%, which is high for a Canadian equity fund. Apparantly there is no free lunch.
Facts needed! Can anyone help?
RSC said: "Most believe they [managers] can [reduce risk]. So even though many of them know in their hearts that their performance is not likely to beat the index over meaningful periods of time, they believe that they add value by reducing risk/volatility. "
My previous post (24Nov 12:22) indicates that the 5 year standard deviation of managed funds is not substantially different from that of the index.
I'd like to believe that management can reduce risks, but can anyone substantiate this?
TIPS do indeed pay a quarterly dividend based on the dividends paid by their TSE35 holdings. Since the constituent stocks pay dividends on a staggered timetable, the TSE (which manages the TIPS and HIPS "closed-end fund") gets the bulk of its management fee primarily by investing these cash dividends (i.e. the ones from the TSE35 companies) in short-term paper until the next TIPS dividend comes due.
So you're right that the lunch isn't entirely free. It costs you essentially the foregone interest on the dividends.
How can an individual investor "buy" HIPS and TIPS directly (from TSE?) and incorporate these investments in his/her RRSP? As Rick mentioned before, the idea here is to avoid the MER that companies like TDGL charge for their index fund (1.1 %). Maybe Rick can help in this regard.
Create a self directed RRSP through a discount broker. TIPS and HIPS trade as stocks.
Index funds do not rule out active managers. It has been very difficult for active mangers to keep pace with a market that has gone straight up. All cash is bad and you want to be 100% fully invested. But remember that 1968-1982 (less 14 years) the market return was 0% (or worse) compounded. But many active manger made alot of money in gold and oil and real estate stocks. Don't let the last few years be a guide. But also make sure you pick the right manger. I'd think Warren Buffet > Index Funds > Frank Mersch.
Just to reinforce Bylo's point regarding the MER's of TIPS and HIPS,I'll quote the TSE from one of their booklets on TIPS:
"Regular dividends and other distributions of the 35 companies in the Index are invested by the trust.At the time of the quarterly distribution,dividends flow through to TIPS holders,in full,without the deduction of expenses or fees.Revenues generated as a result of deferred payment of dividends and from securities lending activities are used to cover the expenses of the trust.Any shortfall in the payment of the expenses is paid by the Exchange.Any excess revenue of the trust after payment of expenses is distributed to the holders of TIPS."
With regard to trading TIPS,the TSE states as follows:
"TIPS trade in board lots of 100 units---(thus a board lot would currently trade for about $3550.00)---.Investors may buy TIPS on margin,and short selling is permitted.As with other listed securities,investors can buy or sell the units through any member of the Exchange registered as a broker or dealer in the province where the investor resides.In Sept. of 1991,the TSE introduced decimal trading for TIPS thereby reducing trading increments from $0.125 to $0.05.Tighter spreads on TIPS provide better pricing for investors.By initiating this change the Exchange is answering investors' wishes for enhanced marketplace efficiency.Furthermore,TIPS has a Minimum Guaranteed Fill(MGF) of 15,000 units at a 5 cent trading increment."
BTW,institutions trade heavily in TIPS.Many mutual funds also hold TIPS in their portfolios.I wonder why?
Active management does not equal active trading or high turnover. It only means that a management team is actively involved in buying and selling decisions. Buying an index fund will guarantee you never match the index because you get index returns less MER. TIPS and/or HIPS are a better indexing alternative.
Remember that although 75% of Canadian mutual funds underperform the index in good times, over 80% of actively managed funds outperform the index in down markets.
Rick, thanks for the "chapter and verse".
People on other threads have blamed the recent sub-par performance of funds like Trimark Canadian on their unmanageable size. Trimark Canadian invests in about the same number of stocks as the TSE35 (although not necessarily the same ones)and has an asset base of about $10B (including its DSC clones.) As I recall, TIPS now have an asset base of some $5B.
Using the same logic, have HIPS now also grown too large to be manageable? Shouldn't therefore the performance of the TSE35 significantly trail the TSE100 and TSE300? That's not what PALTrak reports. Why?
Using the same logic, have HIPS now also grown too large to be manageable?
Since an index fund is not managed, it cannot be unmanageable.
Let me rephrase, if the size of Trimark Can (and DSC clones) is now "too big" then shouldn't it follow that (a) Trimark's purchases would artificially drive up the prices of those stocks they invest in? (b) likewise the purchase of TIPS would artificially drive up the prices of the TSE35 stocks? (c) those stocks that are both bought by Trimark and are in the TSE35 would be grossly overpriced? (d) HIPS (and Trimark) should greatly outperform the TSE300?
Hence, by reductio ad absurdum perhaps Trimark Can isn't "too big" after all?
Bylo, here's one to think about re. "Is Trimark really too big after all".
What percentage of the overall Canadian equity universe does Trimark make up. Let's say, for arguement's sake, it's about 3%. (I don't know the actual percentage - maybe I'll figure it out tonight) Now, given that the Canadian equity universe has grown an incredible amount over the past 5 years, what percentage did Trimark make up back then. Maybe 2 or 3%? Has Trimark really grown that much when you consider the growth of the overall markets that it invests in. I don't think so. (although I will agree that they have grown so much as to make managing the fund more difficult than a smaller fund)
As for artificially driving up the prices. Two points. If all the money in the Canadian equity market were directed at the world's equity markets would we artificially drive up prices around the world. Given that we make up about 3% or world market capitalization, I don't think it will have more than a 3-5% effect. (the percentages are roughly the same for Canada on a global scale as Trimark is on a regional scale - and Trimark can invest 20% outside of Canada)
Second, if the power of Trimark and TIPS/HIPS - etc were true, why the markets declines? Someone with a greater amount of power would have to sell to drive the prices down. Still, you have to believe they have some sort of effect with their equity stakes.
Ontario FA makes an excellent point, as does Da Bull. Index figures have an end date bias which skews the results clearly in their favor. In a bull market there is no doubt that it is harder to beat the index, although a good number of good managers still do. In a bad market it becomes easier to beat the index. If we all knew when the bad times were to come, we could all react perfectly, right. Ontario FA, bang on with your other point about guaranteeing NOT to beat the index. As Bob Krembil recently stated, I look at the index and I see a lot of companies that I wouldn't own. With an index fund you have no choice.
Which brings me to Randy. 95% convinced of buying the index, hey? All I can say is that you have to think like a true contrarian. It used to be about 10 years ago that the talk was "all you have to do to beat the index is buy some small caps". With their higher growth rates, they allowed most to beat the "slow and lumbering" indexes. Now, with a couple of years of the big companies having good growth and the small-caps having bad growth, index funds look great. Will it last or revert to the norm? If you buy index funds today, will you be kicking yourself in 10 years when everyone is talking about how poorly index funds have done?
Now, as JD like to put it, I have a vested interest in this. But I tend to believe that index funds have had their day in the sun, and active management will swing the pendulum back in their favor.
Sask - the problem with contarians is they spend too much time being wrong (and are proud of it). Besides I'm arguing against any strategy (including a contrarian one) that involves picking or timing because I haven't found any that beat the index on an after tax basis.
Da Bull - if managed funds outperform the index in down markets, then they must do it in one of two ways. It could be the effect of their constant cash holdings, which I can do myself for a much lower MER :-) . The other possibility is that the have switched holdings in anticipation of a decline. This passes on a realized gain which is the point of this thread. Here's a real life example: not counting this year, Trimark's biggest ever distribution was at the end of 1987; sure they outperformed the index, but investors had to pay tax on 17% of their year-end holdings.
Being down on mutual funds lately, I went to see a full service broker today (first time in my life) to see if he could talk me out of the index into a more focused strategy with selected stocks. Didn't go well. I made the mistake near the beginning of the meeting of asking him if he could show me some historical evidence that a client following his recommendations would have outperformed the TSE on an aftertax basis. I should have know better!
Yes Sask.,I can remember when mutual fund managers knocked TIPS and Index Funds because they were too heavily weighted in banks which were for a long time a drag on the TSE35 Index.In fact,as recently as mid-1996 Frank Mersch was still in this camp.Now they knock TIPS and Index Funds because they are too heavily weighted in metals/minerals and golds.
The bottom line is that in the long run TIPS and Index Funds will give higher returns than almost all actively managed funds,and will do so with a much higher tax efficiency.So for the long term, for non tax-sheltered investors,there is little doubt where their portfolios will grow the most.
In the long run,you don't have to beat the Index to beat most actively managed funds.Matching the Index will do the trick.
It's boring....but it works.
"asking him if he could show me some historical evidence that a client following his recommendations would have outperformed the TSE on an aftertax basis."
If everyone would ask their broker this question.... well, there would be alot fewer brokers. Everyone I know would have to quit, thats for sure.
And now we are going to be bombarded by all the bleeding heart stock jockeys out there who can remember something they bought once in their life that actually went up. While they still owned it.
Paid to trade. Thats all. bah bye
There is still something I am missing on this talk about index funds and taxes. The companies on the TSE 35 pay dividends. This no one can dispute.
TIPS flows the dividends through to the shareholders quarterly. How do you think TIPS is more tax efficient if it pays dividends which total 4% per year. Not every actively managed mutual fund declares dividends every year.
I don't buy the arguement that sometimes active funds pay higher dividends either. Sometimes active funds grow faster too.
Randy, did your tax calculations take into account the dividends paid out to unitholders of TIPS? If not, how are numbers different? Also, is the rate of return quoted for TIPS inclusive of dividends, which have to be taxable?
Brethren...Bang on...I was wondering the same thing last night when I created the Sector Funds thread.
In my 24Nov/8:44 post I use the tax efficiency of the GL fund as a proxy because I didn't have TE information for the TSE 300. Hence I included this caveat: " However, my guess is that the TE of the true index would be slightly less than GL's index because without the management fee, dividends would make up a larger portion of your net return. So, the "bar" is likely a tenth or two of a percent lower than my calculated results: big deal. "
Active funds will always pay higher distributions unless they're dumping a lot of loosers. These distributions may contain dividends or other income but will mostly be capital gains.
If you want, you can calculate your own TE based on the assumption of a 4% dividend. In the 50% tax bracket you would loose 37.5% of 4% to tax (.375*.04=.015). Tax efficiency represents what you have left over (1-.015=.985). Depending on your province, dividends in the lowest tax backet are taxed at around 8% so TE=1-.08*.04=.9986
Hope this helps.
FWIW, today's Globe & Mail reports the following:
Re. the issue of 'yea, but let's see how well those index funds do in a down market...":
I would certainly expect the majority of actively-managed funds to outperform index funds in a down market. Common sense indicates that, during a market downturn, if fund A (an index fund) is fully invested (as always) and 'cautiously-managed' fund B is holding 20% of its assets in good ol' T-Bills and another 20-30% in stocks that tend to hold up better than others during market drops, the only way fund B would not 'outperform' in a declining market is if the remainder of the securities it holds tanked so badly that it caused the overall portfolio to dip further than the Index fund (that would be quite a feat indeed).
Before investing in ANY instrument, I believe that two of the key questions a person must ask himself are:
1) Why do I want to purhase this investment instrument (ie, what investment objective am I trying to achieve by investing in this security)?
2) Is this particular instrument the best way to go about meeting the objective I identified in question 1?
If there is agreement among us that the above two questions are important ones to ask ourselves before buying a given investment vehicle, then I just don't see any validity in statements that go something like "yea, index funds have done well during the great bull market run over the last few years, but they won't outperform when the big bad bear comes'a knockin'....". Let me explain.
Historically over the long term, markets increase more often then they decrease, and the overall trends has been up (no earth-shattering revelation here, right?). Therefore, assuming that you don't engage in such practices as short selling, etc., people buy equity mutual funds to include in the 'growth' portion of their diversified portfolio and pay the resulting MER because they have observed that, throughout history, eqities have outperformed money market and/or bond instruments over the long term, and they are willing to take on the added risk/volatility that equities tend to experience along the way (as well as the additional cost vs. GICs, T-Bills, etc.) because the hope (expect) equities to rise in value over the course of the time period in which they hold such funds. If not, then they must ask themselves why they would want to invest in equities at all.
If the preceeding paragraph jives with your own reason for buying equity funds (in answer to question 1 above), then, in my opinion, an equity mutual fund/index fund that is fully invested at all times is the OPTIMAL vehicle to achieve this particular objective (ie, answer to question 2). In other words, use the EQUITY mutual funds to represent that portion of your portfolio that will do as well possible when EQUITIES do well (for isn't that the whole reason you bought them in the first place?). Then, fill out the remainder of your portfolio with the optimal vehicles that will address your other goals for the portfolio:
eg. For that portion of your portfolio that you wish to protect from a market downturn, use the optimal instruments designed to do just that (eg. GICs, low MER MMFs, etc.) instead of hoping your 'defensive-style' equity manager holds enough cash in her portfolio to blunt a market downturn (and paying a real premium for holding cash in a high MER vehicle all the while...). Again, ask yourself WHY you're investing in that particular equity fund...if it's because you want to get some downside protection, wouldn't it be easier, less risky, and provide greater peace of mind if you simply decided to allocate the 'equity' portion of your investment to a fully-invested equity fund, and allocated the 'don't want to lose it in a bear market' portion to an instrument that is specifically designed to do just that (eg. a GIC, Canada Savings Bonds, T-Bills, a money market fund, etc.)? Naw, that wouldn't be any fun, because that would mean you wouldn't have to worry about how well the equity fund you own will hold up in a bear market (because you'd already know how well the T-Bills you own would do in such an environment), and your overall cost for the sum total of your investment portfolio would be lower to boot, given that you're not paying a high MER so that the manager can hold some cash for you.
Sory for rambling on like this....obviously, there are a lot more factors to consider before implementing a sound financial plan, and by no means am I trying to tell people that this is all there is to assembling a portfolio that's right for them (every investor is unique) - I simply wanted to state my belief that people sometimes end up incurring additional expenses or find themselves with an investment portfolio that doesn't do what they had hoped it would do simply because they didn't actively seek to use a each investment vehicle they own in the manner in which it was supposed to be used.
I have owned TIPs ever since they were invented . They have beating the hell out of Frank Mersch.
Have been investigating TIPS & HIPS . Also listed on the TSE are TIP.ET.S and HIT.IP . What are these instruments and how are they related ?
Waxman,TIP.P's are Toronto 35 Index Dividend Capital Reeipts and TIP.WT.S's are Toronto35 Index Secondary Warrants.Neither are very liquid (ie. extremely low trading volumes),therefore I would not consider trading in them.
Thanks, Rick, Appreciate your help.
Bylo - thanks for the reality check on index yields. I was using Brethern's 4% for demonstration purposes only.
Colt - Good points. From a slightly different perspective, one could argue that if good fund performance in a down market is due to -
"nothing stays good forever and will eventually fall victim to the previous point (example: Trimark" Good point Bylo,
Did you know that in 1987, 8 out of the top 10 funds, based on 10 year returns, belonged to Mackenzie Funds.
Is Trimark due for its rough period now ?
Good observations - I agree.
I personally prefer to use mutual funds/index products for my equity holdings, as I don't feel comfortable picking individual stocks. You're right on re. ideally being able to buy a limited number of individual stocks which are long term holds, thus freeing yourself from being at the mercy of an equity fund manager re. taxable distributions paid out by the fund, not being pressured to sell your securities to meet fund unitholder redemptions during periods of market carnage, etc. However, after reading the stock selection approach of that master investor, Warren Buffett (as outlined in the book 'The Warren Buffett Way' by Robert Hagstrom Jr.), I realized how much time and effort it takes to properly value a business and monitor its management and progress. Since I don't have the time to do a thorough job of selecting and monitoring such stocks, I prefer to go the mutual fund route to get equity exposure.
Nonetheless, I do agree with you that, ideally, if one could pick a limited number of individual North American stocks which are long term holds and combine them with index instruments and a select number of foreign mutual fund holdings to achieve global equity diversification, you'd get about as close as you can to having the 'best of all worlds' outside your RRSP. However, as with many things that are ideal in life, it's easier said than done.
Randy (et al)
Now that y'all (including moi) are "95% convinced to buy the index" [Randy on 24Nov], let me point you to an article in this morning's G&M ROB on page B19 entitled "Risk, after all, is in the eye of the beholder" (couldn't find it online.)
It's about Stanford/Yale prof Mordecai Kurz, who claims to have "proved" that established financial dogma, including Modern Portfolio Theory, random walk theory, Markowitz, Sharpe, etc. is to quote the article's author, "scientifically, complete and utter bunkum".
The search for truth, financial security and the occasional free lunch continues... ;-)
hehehe....I saw this too. Made my day! Anyway, I didn't get to look it over yet, but you can download his paper at http://www-econ.stanford.edu/econ/workp/swp96003.html
Still a '95er... haven't digested enough contrary opinions yet. I'll have a look at the article tonight, Madelyn - thanks.
For those interested, here's a hot link for TIPs and HIPs. I was surprised at the difference in their market cap: $3.2 billion for TIPs, 700 million for HIPs.
Randy,TIPS have traded since March 1990.HIPS only began trading in October 1995.
Another factor is that exchange-listed options are available on TIPS but not on HIPS.
The article you referenced unzips as a .ps file (and a big one: 8M) but I can't find an application to read or print it. Any tips?
The .PS probably means it's in Postscript format. Most laser printers can handle that, although it may be an "option" on some.
I only got as far as reading the abstract. I'll wait for someone else to translate the paper into plain English. :-)
Randy, are you sure you are saying BUY instead of SELL Indexed Funds ;-)? After the TSE performance of the last two days I really wonder! Go to http://quote.yahoo.com/m2?u and notice that today even the stinking Bovesa in Brazil managed to gain 2.43%.
How does the bid/ask get set for TIPS and HIPS ? I know they trade just like stock and that they must also mirror the index but what prevents the price from becoming slightly disconnected from the true index. Does the TSE somehow handle this or is it up to market sentiment. If the ladder was the case then they would turn out to be more like options. I know (I think) that this isn't the case.
Note to Bylo:
Hey, genius. Because costs matter in bond funds doesn't mean they matter in equity funds. Check out the spread between the five or ten year returns of 1st and 4th quartile income funds. Its not much. Check out the similar spread in Canadian equity funds. Its huge. So if the spread between 1st and 4th quartile in bond funds is small, higher costs is going to impact performance significantly. In equity funds though, the impact is MUCH less significant.
Chew on this for seconds. In constructing a bond portfolio there is one factor that dominates all others - INTEREST RATES. IN constructing an equity portfolio though, no single factor dominates. This means that it is possible (though of course it doesn't always happen) that incurring higher management costs will result in higher NET returns.
That big word is b-r-e-t-h-R-e-n. I don't think brethern has a a meaning, let alone a gender.
Read this Costs Matter and especially the longer paper it links to.
Then, when you've got a civil tongue (or keyboard) come back and let's talk.
Randy, I had the same problem. But, I found a page where you can view 5 of Kurz's papers in PDF format. I looked at one that was 39 pages, so no I haven't finished reading it yet. Anyway, this page is at http://www-econ.stanford.edu/econ/workp/
reader rabbit, ...time to go back to your bunny hutch and read a bit more!
I got the article - the old fashioned way (copied the .ps file to the prn: device at the DOS prompt!)
I'm only half finished it, but you were right Bylo, it's predominatly greek. Have you even seen a mathematician try to develope equations for the human though process? Nevertheless, my university education taught me how to read (ignore) this kind of hyper-intellectual crap.
So far his hypothesis is quite interesting (and somewhat intuitive). He certainly doesn't support the efficient market hypothesis: after all, if markets were efficient then, baring external factors, volume would remain steady at the level required to support liquidity of the money supply (ie: people wouldn't trade for gain). He argues that 2/3 of market volatility is due to internal factors (ie: expectations) which can not be factored in 'efficiently'.
At this point, sleep became more important.
Obviously, that same university education didn't teach me how to type and spell at the same time.
There's a guy in Canadian Money SAver, who has a model porfolio designed to beat TIPS. I recieved a comp copy and havn't studied in any depth, but the principle I presume is to hold a representative stock in the up trending sectors, and avoid the flat or declining sectors ie. precious metals, mines, non performers. As an individual investor you have much more flerxibitiy than a money manager. Sounds like it could work. What's the catch? This guy is currently beating TIPS if only by a hair. I'm surprised considering the knowledge and know how displayed on this thread, that more of you aren't avoiding MER's altogether and simple buying stock.
Another Note to Bylo:
Since Bogle is the Chairman Emeritus of Vanguard, and since Vanguard is THE index fund seller in the US, and since index funds have low expenses, it comes as no sruprise that Bogle believes costs matter. Just because you make a speech about it doesn't make it so though. There's a similar study reported in Bloomberg Personal. Bloomberg's study is based on Morningstar data. It found that while low cost bond funds had better 5 year returns than high cost bond funds (big surprise) high cost small cap funds had better returns than low cost small cap funds (how can that be?)
The reason so many people focus on costs is that its easy to do. It doesn't require any thoughtful consideration of investment approaches, management stability or that hard to do stuff. Look up a number and express an opinion. Even a journalist can do it. So they do. In droves. And poor schleps like us have to read their drivel. But it ain't necessarily so, bylo.
Further to my posting of 5:00, I'm serious. I read on these threads endless complaints about MER'S
... tortured agonizing about random theory, crabbing about money managers. Come on, why not do it yourself. It's not as if you don't have enough time, if you're spending so much of it here! Why not do it yourself? You can easily find out what the funds are holding on the net. BCE is one of the favourite holdings, "former bond trader" says banks are being re-evaluted (downwards) why not pick up one of those on the cheap? Andre Marson, manager of the Scotia excelsior fund, told us all in the Globe last weekend that he liked, B of M at 66.5, it's around 60 now. And don't forget a fund company, since Peter Lynch has told us we should invest in something we know about, and judging by these threads there are an awful lot of people that are extraordinarily knowledgable on the subject, how about AGF which was recommended at 68.55 in Investor's Digest. Or Trimark which was recommended at 79.65. Look at it to-day. We've all been told that we would make much more money investing in the fund companies than in their products. My suspicion, and please someone show me I'm wrong, is that we hire managers so that we will have someone else to blame if things go wrong.
Well, wascally wabbit, time to wegognize that life in the business is not as wosy as you see it. I have my own arguments against index funds, but it is not based on cost, which is a very legititmate argument, not to mention concern. Your outlook indicates a short time in the business. You should have the maturity to recognize that, and sit back and reflect in your bunny hutch.
You should also reflect upon your apparent obsession with Bylo. Trust me, don't try to match wits here. You will be taken down, not only by Bylo, but by other informed investors and FP's like myself. Read back a few hundred threads young bunny, and then come back and express your opinions.
Doc, are you referring to the David Stanley articles in the MoneySaver? If so, you must tread carefully, as even Mr. Stanley himself admits that the back-tested data doesn't go back too far. If I were you, I'd have a look at how that portfolio looks today. Also make sure that you compare it to the Total Return Index Value for TIPs, as Mr. Stanley suggests, and not just to TIPS.
I'd like to hear your arguments against index funds that track large-cap stock indexes like the TSE and S&P 500. I hope you haven't already explained them at length before (at least not lately).
She's baaack!!! Look out young bunny!
Welcome back Madelyn, witty as ever!
I glanced through Kurz's article, Endogenous Uncertainty: A Unified View of Market Volatility - The Horror! The Horror!! Oops! Wrong Kurtz.
I don't think we have to worry about Modern Portfolio Theory, or the Capital Asset Pricing Model being thrown out the window just yet. From what I can glean from Kurz's paper, what he is saying in 32 pages is that expectations matter, or in other words, expectations are primarily driving the short term volatility observed in the stockmarket.
So don't hold your breath just yet. That elusive free lunch is still up for grabs.
Madelyn you said regarding reader rabbit ...
>Your outlook indicates a short time in the business. You should have the maturity to recognize that, and sit back and reflect in your bunny hutch.<
Maybe and maybe not. His point is valid re: importance of MER's re: bond funds or equities. Far more important in bonds than equities. (Although I doubt any experienced forum contributor recognizes the folly of reader rabbits implied assertion that costs are not meaningful)
While I don't condone his (her?) rudeness to Bylo (a regular and appreciated contributor to this forum), certainly your assertion regarding index funds not very useful to readers here (an opinion without any accompanying rationale, facts, etc). Perhaps you could elaborate on your opinion: maybe rabbit is right and you are needing to reflect in your hutch? We just don't know right now, do we?
Reader rabbit, if you don't think costs matter, then go read some of the Chairmans letters (e.g. Warren Buffet) from Berkshire Hathaway, regarding costs. He very much admires managers who are always scrutinizing costs and is justifiably proud of his own "mutual fund company" costs (Two, yes only 2 basis points: i.e. 0.02%). His company has produced a return on equity of nearly 24% p.a. for 32 years; and if he feels costs are important, then either your opinion is suspect, or his is (I think I'll go with the big cheese on on this one).
Madeyln and Colt, here is something which may interest both of you (for different reasons), which came from Warren Buffetts' 1996 Chairmans letter:
"Let me add a few thoughts about your own investments. Most investors, both institutional and individual, will find that the best way to own common stocks is through an index fund that charges minimal fees. Those following this path are sure to beat the net results (after fees and expenses) delivered by the great majority of investment professionals.
Should you choose, however, to construct your own portfolio, there are a few thoughts worth remembering. Intelligent investing is not complex, though that is far from saying that it is easy. What an investor needs is the ability to correctly evaluate selected businesses. Note that word "selected": You don't have to be an expert on every company, or even many. You only have to be able to evaluate companies within your circle of competence. The size of that circle is not very important; knowing its boundaries, however, is vital.
To invest successfully, you need not understand beta, efficient markets, modern portfolio theory, option pricing or emerging markets. You may, in fact, be better off knowing nothing of these. That, of course, is not the prevailing view at most business schools, whose finance curriculum tends to be dominated by such subjects. In our view, though, investment students need only two well-taught courses - How to Value a Business, and How to Think About Market Prices.
Your goal as an investor should simply be to purchase, at a rational price, a part interest in an easily-understandable business whose earnings are virtually certain to be materially higher five, ten and twenty years from now. Over time, you will find only a few companies that meet these standards - so when you see one that qualifies, you should buy a meaningful amount of stock. You must also resist the temptation to stray from your guidelines: If you aren't willing to own a stock for ten years, don't even think about owning it for ten minutes.
Put together a portfolio of companies whose aggregate earnings march upward over the years, and so also will the portfolio's market value.
Though it's seldom recognized, this is the exact approach that has produced gains for Berkshire shareholders: Our look-through earnings have grown at a good clip over the years, and our stock price has risen correspondingly. Had those gains in earnings not materialized, there would have been little increase in Berkshire's value."
But hey, go take a visit if you're interested.
PS: wascaly wabbit, unless you are uncomfortable with your opinion (and NEED TO SHOUT OR BE RUDE TO HAVE IT HEARD), then there's no point in being rude about it.
Facts and rationale will carry you far further in this forum than rude comments. Bylo is an appreciated contributor around here, who is not always ready to accept c.w. Further, he isn't rude when he expresses his opinion, a fact which probably helps it carry greater weight than yours.
Wow! Thanks for coming to my defense folks!
I was expecting reader rabbit to respond to my post of yesterday and I had some Buffettisms all ready to fire back, but it looks like Jay beat me to the punch. Thanks.
Let me add another Buffettism from his latest annual letter:
Seriously, costs matter. For example, equity mutual funds incur corporate expenses - largely payments to the funds' managers - that average about 100 basis points [that's in the US -- double or more when you cross the border], a levy likely to cut the returns their investors earn by 10% [20%+ in the GWN] or more over time. Charlie and I make no promises about Berkshire's results. We do promise you, however, that virtually all of the gains Berkshire makes will end up with shareholders. We are here to make money with you, not off you.
[Re the last three sentences, with the exception of Vanguard which is a "mutual mutual" fund company, who else can truthfully make that claim?]
For even more on the topic of indexing and costs, as well as a fascinating, free trip down memory lane, see Bogle's new article The First Index Mutual Fund - A History of Vanguard Index Trust and the Vanguard Index Strategy.
Finally, let me be perfectly clear that I am not advocating index funds as an investment panacea. It seems to me that for large cap investments in developed countries it's awfully hard to consistenly beat the index. Sure there are some "star" managers like Templeton, Kembril, Lynch, Buffett et al who seemingly defy the odds, but very few survive over the long haul.
Ahhh, if only we could predict the future. Failing that the funds that seem to perform the best over time are those that charge the least. Not always but more often than not. Since there can be no guarantees about achieving success in the investment game, all we can do is to try to improve our odds.
BTW, Bogle's history points out that there were some significantly long periods (1977-82, 1991-93) in the past 20 years when the S&P500 failed to make it into the top half of the ratings. Indexing is clearly a buy-and-hold strategy.
However, if you want to invest in small caps, developing/emerging nations, etc. where there is far less evidence of market efficiency (the reports of corruption that are coming out of Asia suggest there is no evidence of market efficiency), then I agree, indexing is not appropriate.
As always, caveat investor!
Madelyn, welcome back. We all missed ya.
John Galt, Madelyn recently wrote a piece on indexing Index Funds & TIPS???.
jd, Touch your screen. My relief is palpable. ;-)
jd, thanks for your comments on Kurz. I partially agree: his model states that expectations are causal but random contributors to "local bubbles" (short term volatility). But he also concludes (in his Nov 95 paper) that there are longer-period "stationary environments" during which agents (traders, managers, etc.) can learn to outperform - currently with a buy and hold strategy. The trick is to learn fast when you recognize that current bubble is in fact an environment change. This is not rocket science (however, he did manage to use that "heteroskedasticity" word).
In light of our current doubts that management is worth the price (MERs and prepayment of taxes), I suspect Kurz would agree - although not with our reasons. I believe he would argue that when you recognize an environment change you need to fire all your managers and get new (young) ones who can learn fast. Between '65 and '82, the best (and not uncommon) strategy was to repeatedly buy the Dow at 750 and sell at 950. I wonder if the same strategy would hold up with today's higher taxes?
doc - no argument with your comments, except that my education on picking good companies is not nearly as advanced as my understanding of mutual funds; neither is yet good enough to justify my next major investment, which will be fully leveraged.
Thanks for the link to Madelyn's article, Bylo. Since I do believe markets are efficient (at least the TSE & DOW) I'm still in favour of index funds.
Question: I'm sure that Vanguard can't sell to Canadian residents, but is there a way to buy it anyway - e.g. PO Box in US? It seems like you might know.
John Galt,re. purchasing Vanguard funds,check out the Jack White&Co. thread----last message was on Nov.23/97.
Stationarity and heteroscedasticity are terms used in time series (stock market) and cross-sectional analysis. They loosely mean the same thing, with heteroscedasticity used in cross-sectional analysis and stationarity used in time series.
Heteroscedasticity is a fancy term for unequal variance or dispersion. If you have stock of asset wealth growing along a stochastic trend, the trend is said to be heteroscedastic if the random dispersion about the trend line grows with the asset size. If the dipsersion around the mean growth trend is constant it is called homoscedastic.
Loosely speaking, a times series is stationary if its mean value and its variance do not vary systematically over time. Whenever dealing with time series data, its stationarity is the first thing tested for.
I have never come across an economist who would agree that a fund manager can consistently beat the market. This may explain why few economists work for mutual fund companies :-)
jd,reminds me of the joke....why did God create economists?
To make weather forecasters look good.
No disagreement there, Rick. I'd much rather forecast an inanimate physical pattern like the weather over trying to predict human behaviour. :-)
jd,couldn't agree more!Good comeback.
jd - Wow! I thought you were an actor and just "played" at this stuff. Guess not.
Well that was an interesting diversion, but it didn't convince me not to stick with an index for fully taxable domestic (&US) investing.
Timing, if you're inclined to try, is obviously a strategy for tax-sheltered money (interestingly, this virtually precludes the usefulness of short term leveraging).
Value investing, on the other hand, still has some undisputed merit (although less, if the money is unsheltered). I'll have to spend some more time with Madelyn and Buffett (juxtaposition intentional) this weekend to get my thoughts straight. Thanks for the links Jay and Bylo.
Surely there are other fund managers that follow the value investing approach that could beat the index. Buffett seems to be saying in his statement that he is the only one.
I only use index products. I have no problem with active mangers and some are better then others but how does one know? AIC has been great but I'd argure that the've been lucky. They took a big bet on financial serivces and won. Templeton this year took a big bet on Asia and it blew up in their face (so much for the risk in the U.S. market). Altimira took a big bet on gold and resources and lost. For every index beater there seems to be a few losers. There is no way to know before hand. By the time you do relize its too late. Since its too diffcult to say who will be be next years or ten years winner its better to just buy the index and stop losing sleep. By owning the index one will still get the best compaines as they rise to the top.
This is one of the most interesting and factual discussons I have read in a long time.
Jay, I guess we should all line up and purchase shares of Lowen. I don't have any distinctive competence in that field though.
I believe it is clear that it's very hard to beat the index in a bull market. A rising tide lifts all boats! Madalyn's comments about about a bias existing in TIPs (on another thread) explains the above.
Its also obvious (to me anyway) that the fund managers are often splitting hairs when they choose one company and cast another aside. Thats why the core holdings differ from fund to fund so much.
But how will an index fund hold up in a bear market?
It should be a simple thing for a fund manager to identify at least 25 companies which will have flat or negative growth. Discarding the poor performers (1/12) of the total) should more than compensate for the MER. Why is this so difficult?
Are they trying to be home run hitters when all we need is a team of singles hitters who hit 300 or better?
The difficulty your going to have Matador is survivourship bias. Those funds that you attempt to measure to see how they performed in the last bear still exist today. But hundreds of poor performing funds have been burried by the fund companies. Funds that went under or were merged. What you are suggesting is the proper way to look at the situation but you must include all fund even those that are gone.
Also Matador, if you believe markets are efficient then, while you may be able to identify companies with bad growth prospects, those bad prospects are already reflected in the stock price.
It can't be this simple, but why not use the Club Price or Costco approach.
They did a survey and realized that in the retail business 80 - 85 percent of the profits are made with 15 - 20 percent of the merchantise. They started selling the profit makers in bulk.
Why not just sort the portfolios of the sucessfull funds and buy the companies that are common to most funds?
The reverse strategy could be used to identify the dogs and eliminate them.
If Trimark, Fidelity, & Dynamic funds purchase Bank of Nova Scotia stock and none have Repap, thats a pretty strong statement.
Perhpaps there are ethical reasons why everyone tries to reinvent the wheel.
I don't want to belabour the point, but again I'd refer back to efficient market theory. In your example, there would be no point buying BNS after it has already gone up, since that tells you nothing about how it will behave in the future. All the economic expectations about BNS's future will be reflected in the stock price already. If those funds made money off it, they were lucky. Thus there is no disadvantage now in buying Repap, since if it has bad prospects those are already accounted for in the stock price.
This is why index funds are so useful - they keep the one predictable factor (fees) low.
John, if the market knew all there was to know about a stock and it was all in the price can you explain some pretty smart selling by the insiders of Corel. Obivously the market isn't that efficient or it would have relized what was going on like the guys at the company.
This examples proves the rule. Efficient markets account for all PUBLIC information in the stock price. If you have private, insider information, you hold an advantage over the market because you know something it does not. Thus you are able to buy (or sell) in such a way as to make huge profits. If the market knew what the insiders knew then the stock price would reflect it. This is the reason that so much emphasis is placed on full and true disclosure by companies.
An interesting offshoot of this is to ask whether insider trading should be illegal. There is an argument that, by changing supply or demand and thus altering stock prices, insider trading actually helps the market reflect the true value of the stock, which is beneficial to all.
Re; this weekend's Globe and Mail article " How much diversification" Who are these people, stockbrokers. You want cheap diversification, buy TIPS They never heard of covariance either.
Efficient markets: thank goodness they aren't. (Let's get real here: university professors getting us to swallow some nonsense like prices are PROPERLY set by all info currently available - Come on!) Sometimes I can't believe how gullible people are: efficient markets???? Please ....
Don't mean to destroy anyones pet hobby horse here, but if that were true, the "Dow Dogs" would never fall as low as they do. But still they do, year, after year, after year. Kinda blows the efficient market theory all to hell. IMHO.
many misunderstand the eff market theory and try to dismiss it by saying stocks are not always properly priced thus the theory must be wrong.
Seems to me that the eff mkt theory work. At least in the large cap developed markets (e.g. US and Canada). Otherwise wouldn't more managers beat the index in the long run ? Please comment.
I think stockmarkets are approximately efficient. It may not look it in the short run. But over a short period of time unverified rumours float about and individuals may make their decisions based on imperfect information or unsubstantiated rumours (like people picking up Bre-X shares for pennies a share in the Spring, gambling on the rumours that the Bre-X hoax wasn't really true). Over time rumours are substantiated or dispelled; full information is eventually diclosed, and in the long run stockmarkets are pretty close to efficient.
There are no absolutes in our world. There exists no perfectly competitive market anywhere, and stockmarkets are not perfectly efficient in disseminating information. However that doesn't mean they are useless constructs. These abstractions are useful as benchmarks by which we can measure the degree of competitiveness or efficiency of a particular stockmarket.
That is why fund managers cannot beat the markets in the long run. So what about the impressive performance of AIC Advantage? How have this fund's managers beaten the market for the past 10 yrs? Simple. They haven't been playing the market - just a small subset (not so small as when they started, I guess) of it. So the claim that they "beat" the market isn't enirely valid.
Since you only invest in index funds, how do you structure your portfolio to be properly diversified?
Ha Ha Ha. JD, that's a good one.
Now, just what the hell has AIC been beating over the years, if not the market. Were they maybe the one who set the new land speed record? Talk about reading too much statistics. Step back and think.
Just because they choose to overweight one sector or another doesn't mean they can't be applauded for beating the market. (it's called active management. That's what happens when you don't have to buy the entire market. You can decide to go overweight in one sector) Will they continue to do it in the future. Beats me. But if the bull market stays intact, the people that manage money will continue to profit.
I'm not trying to be a big AIC advocate, I've got my own problems with the fund right now, but this was just too much.
I suppose the fact that Cambridge hasn't beaten the market in a while isn't valid either. Maybe there is a market, the gold sector, that they have beaten. Maybe the management is great after all. Just a victim of being in the wrong subset.
I believe jd's point about AIC was that it needed to be measured against a financial sector index. Being a yankee, you should be aware that Canadian markets are behind the US when it comes to having good submarket indices, but that doesn't change the theory.
Yes, AIC may be beating even a financial sector index recently, but that's not long term performance. Regressing to the theme of this thread: just wait until they rotate sectors and distribute the taxes!
Gummy - yes, but you'd better have your fun in a tax sheltered account. If you want fun - look who's rebounding: Latin America!
Well, I'm 100% convinced. My next domestic market purchase will be an index... now which one? I'm leaning toward TIPs; although HIPs represent slightly more "value", I can use the higher dividend payout. Thanks to gummy's analysis of DCA, I will buy in maximum 3 instalments. Now, when to start (even a buy'n'holder has to time something - where are the separtists when you need'em)?
The S&P 500 or TIPS are diversified. They represent over 300 or 500 individual stocks. (most major global exchanges have a listed proxy). The only other way to diverisfy is to buy bonds or hold cash (I don't own any bonds at all, though there are looking better and better). In my RSP I have two holdings TIPS and SPYs. In my non RSP I own S&P depository reciepts (SPY) . Pretty simple and more successful than the STAR program. I am thinking about bonds and maybe some Japanese Index Options but for now only the S&P's.
Whoa! The intensity of your post is palpable. Just what this forum needs - some intensity! I am not taking anything away from AIC Adv for its performance, and since I own some units I hope they continue this trend. Perhaps I do study stats too much to see the overall picture. I can see your point, if one believes that the proper approach to managing a portfolio is about picking the right sector, that overweighting some sectors is what managing a portfolio is all about.
But I believe this sector rotation method for choosing funds is suboptimal. I think the superior approach is simply to look for low-valued firms with potential, irrespective of what sector they are domiciled. That is why I don't look upon purchases in one specific sector as "playing" the market. It is too constraining - the manager is more or less restricted to purchases within a sector.
All my posts regarding the inability of managers to consistently outperform the markets and I still don't carry any TIPS or HIPS. I am going to unload 10 percent of my E&P Equity in dec and another 10 in jan (I'd like to unload it all :0). I am dithering about whether to put it into TIPs/HIPs or purchase more Bissett Cdn equity. This Bissett fund is the one fund that confounds my position regarding a fund's inability to outperform the market consistently.
Thank you all for a most interesting discussion,
I have some comments and questions:
- With respect to the managers failing to beat the TSE 300, I fully agree. The funds (most successful ones are simply too big to outperform). However, there are those who will not correlate with the index, namely Growth funds (such as Sceptre) who, if bought at the right time, can offer significant gains over the index. This is where, in my opinion, the management fee is worthwhile.
I have three other questions:
How does the TSE 300 stack up against the TSE 200, TSE100 and TSE 35 ?? ( I feel the TSE 35 is the safest). comments ??
How can we here, in Canada, purchase the S&P 500 ? What other interest indices are available. How about the Morgan Stanley world equity index and others. (how does this index compare with, say, Templeton Growth fund ??)
Any input would be appreciated, Thanks , -investor-
jd, I understand your reluctance to commit to a T/HIP strategy. It seems so counter-intuitive, but the facts are pretty clear. Although I said I'm 100% convinced, keep in mind that this thread is predicated with the assumption of a taxable account; the hurdle is set a little lower (although still not met by most) if your distributions are not immediately taxable.
I still have managed funds in my RRSP (Bissett Small Cap, incidentally) and for my kids (mostly country and Sci/Tech). My wife (27% bracket) also has our largest single holding: Trimark Leveraged Fund. In time, I'd like to advance my education enough to replace most of the funds with individual stocks. But T/HIPs will be my sole personal investment. "Sharpe" thinking would say the index has the best risk adjusted return in excess of my leverage costs... that is, of the investments I understand.
I know you're aware that there is no statistical evidence that this year's excellent funds will be excellent or even above average next year. So unless you're willing to go on faith that Bissett is the next Buffett or Templeton, the answer is in the index.
Good luck with your choice. Your odds are the same as a coin toss... less the MER and distribution taxes.
You can buy SPDRs (Standard & Poor's Depositary Receipts -- like TIPs but track the S&P500 index) through any Canadian stock broker who deals with the American Stock Exchange.
Likewise for WEBS (World Equity Benchmark Shares) which seek to track the performance internationally of specific Morgan Stanley Capital International Indexes (MSCI) of 17 different countries. I'm not aware of index funds that are available in Canada which track the broader MSCI indexes like EAFE.
More information about these securities, including downloadable prospectuses, are available on AmEx's website.
Vanguard is a US MF company that offers a very large range of stock and bond index (as well as actively-managed) funds at unbelievably low MERs. While you can't buy their funds directly, you can do so via a US broker who is willing to do business with Canadians. One such is Jack White & Co.. See also this thread.
I can't match Bylo's ability to provide all the right links, but here's a few comments on some of your points that I hope will also be helpful.
"most successful ones are simply too big to outperform"
Actually we've concluded elsewhere in this forum that fund size is not a factor. The biggest funds are only an insignificant fraction of the TSE and Canada is an insignificant part of world markets.
"I feel the TSE 35 is the safest
That wouldn't be my definition of safe. The 35 is narrower and has had the greatest recent runup. To see history, go to a stock charting site and plot TIPs and HIPs.
In addition to Bylo's links, you may also wish to check out the thread Move on to TIPs.[No longer available :-( ...Bylo]
1) Gotta disagree with you re. '..fund size is not a factor' if the name of the game is Canadian Equity funds.
I agree that fund size is much less of a concern when one is holding a Global Equity fund or even a US Equity fund (given that the US market represents about half of the world's stock market capitalization). However, don't forget that Canada represents only about 3% of global stock market capitalization.
Take a fund like Trimark Canadian (please). If it's got $2.5 billion in assets, is required to invest at least 80% of it in Canadian securities so that it remains fully RRSP-eligible, is prohibited from owning more than 10% of the total stock of any individual company, and is faced with the task of managing such a large fund in the current environment (which many consider to be an extremely mature bull market), I suspect that the limited number of stocks that they truly WANT to hold at this time are probably at or near the 10% maximum, OR they simply don't wish to buy any more at current prices. Consequently, its managers must decide on what to do with the cash left over, and it looks like they've decided to take a chance on buying some of that pretty yellow metal and holding the rest in T-Bills/other cash-like instruments and simply wait until the prices of stocks they're interested in come down to what they consider to be levels representing good value.
My conclusion: A $2 billion plus equity fund which must invest 80% or more of its assets in a country representing about 3% of the world's stock market capitalization will have a much tougher time investing the money entrusted to it that a smaller fund with the same objective.
2) Re. the TSE 35 vs. 100 vs. 300:
I prefer the TSE 35 because I believe (and someone please correct me if I'm wrong on this) that the 35 has the lowest % of resource/metals holdings in it of the three candidates. As I mentioned on another thread, I believe that Resource/Metals stocks are not well suited to a buy-and-hold strategy, so I'd prefer less exposure them in an index-type of investment.
3) Along the same line, here's a little tidbit for our panel of experts to ponder:
Though the S&P 500 has proven to be an awesome performer vs. actively-managed funds over the long term (and has literally blew away the vast majority of managed funds during the raging bull market we've enjoyed in the U.S. over the past few years), I'm not convinced that the same can be said for the TSE 300. As mentioned, the TSE 300 is weighted much more heavily in the Resource/Metals sectors than it's American counterpart. This may in fact be one of the reasons the TSE has almost always lagged the Dow/S&P 500 for most years in recent memory.
"Sure", you might counter, "Colt can say that now when resources/metals are taking a beating, but just wait until people get a craving for the stuff mother nature produces...then we'll see who lags who!" True, resources can produce spetacular returns in a very short period of time (and, as we know, can tank just as fast), but I believe that, over the long term, a dollar-cost-averaging, buy and hold investor like myself will generate a better return by being light on Resources/Metals.
Now I haven't done any intricate number-crunching like our friend and resident math whiz gummy, but I have a hunch that, given the TSE 300 must maintain its high Resource/Metals weighting at all times, Canadian equity fund managers have a better shot, even over the long term, at beating the index (even after subtracting a reasonable MER from the active fund's return) than do their US counterparts vs. the S&P 500, since general Canadian equity managers are not obligated to hold such highly cyclical/unpredicatable stocks in their protfolios at any given time. However, the TSE 35, with its lighter weighting in Resources/Metals, may pose more of a challenge, especially given that TIPS has such an appealing expense structure vs. the MERs of actively-managed funds.
Here's a piece of information I just discovered that may shock many an investor in actively-managed large cap U.S. equity funds:
While scanning the Globe and Mail's November 20, 1997 Report on Mutual Funds, I noticed the following:
10-year Average Annual Compound Return, S&P 500: 17.7%
Median 10 Year Return, US Equity Funds: 13.3%
Mean 10 Year Return, US Equity funds: 13.1%
THE HIGHEST 10 YEAR RETURN OF ANY US EQUITY FUND SOLD IN CANADA: 17.6%!
That's right, according to the Globe and Mail's figures, the unmanaged S&P 500 beat EVERY SINGLE US equity fund sold in Canada for the period October 31, 1987 to October 31, 1997. Bylo, you'll be happy to know that the top managed fund return of 17.6% was generated by none other than PH&N US Equity (give yet another gold star to the boys in B.C.).
Now granted, one must keep the following in mind:
- The aforementioned 10 year period excludes the crash of October 1987, which likely affected the S&P 500 more than most actively managed funds given that the S&P 500 benchmark is assumed to be fully invested at all times.
- The tremendous bull run of the past 2-3 years provides more of a boost to fully invested instruments like the S&P 500 than to those funds which hold some cash.
- The above does not factor in any expenses one would incur when investing in the S&P 500 (eg. brokerage commissions and MER if buying SPDRs, MER of an S&P 500 index fund, etc.)
- The US Equity category in the Globe includes small cap and mid cap US funds as well as blue chippers, so comparing the mean and median averages for the US Equity fund category with the S&P 500 isn't exactly comparing apples with apples. However, given that the S&P 500 also beat every single large cap fund listed in the category, one has to conclude that the unmanaged index looks mighty appealing if you're in the market for a US large cap investment vehicle.
Nonetheless, these figures seem to add support to the mounting pile of evidence that suggests that when it comes to US large cap equities, the S&P 500 is pretty hard to beat. Indeed!
Colt,to complement your last post,the following information appeaered in last weekend's Barron's:
Out of approx. 2500 diversified U.S. stock funds sold in the U.S.A.,only 10.5% have beaten the return of the S&P500 YTD.In 1996,the figure was 26.0%;in 1995,the figure was 16.5%.
The YTD return of the S&P500 is 30.6%;Vanguard S&P500 Index Fund is 30.4%.The YTD return of the average diversified U.S. stock fund is 22.3%.
I wonder if any U.S. equity funds sold in Canada have matched or beat the S&P500 Index YTD?
It would certainly appear that SPDRs or Vanguard S&P500 Index Fund is the way to go for Canadians investing in U.S. large cap stocks.
I think you are bang-on with your comments about the TSE being dependent on resource stocks. I would also have concerns about the TSE 35 though, given what I believe is its heavy emphasis on financial stocks (banks). It seems to me that the two most unpredictable things in the economy are commodity prices and interest rates, and it seems that the health of the TSE is connected to both!
Since the future earnings (and thus stock price) of so many TSE companies are beyond the control of the companies themselves, the whole market starts to look like a gamble on interest rates/commodity prices. Not what I think the average Canadian investor has in mind for their RRSP, which is why mine is only 20% Canadian stocks v. 50% foreign stock. Sure resource stocks may have a good run from time to time, but you wouldn't see Buffett messing with them. Cheers.
Actually Scooby, that is not true. Buffett has owned Handy and Harmen (silver) and also Champion International (forest products).
But in general, yes, he avoids them.
Colt & Scooby et al,
Interesting observation re S&P500. When weader wabbit took his potshots a week ago (hey, what ever became of him...did some Amurrican mistake him for a turkey at Thanksgiving dinner?) I looked at PALTrak numbers. Since I couldn't believe that the S&P500 index beat all Canadian-based US equity funds over 10 and 15 year periods, I didn't cite that then -- it seemed too incredible to be true. Thanks for saying that it is so. BTW, my PALTrak data is Jul97. The 10 year numbers include the 1987 crash. Same rankings but the 10 year CAR numbers are about 200bp lower.
Also, go over to the GlobeFund site and create a chart of PH&N US Equity vs S&P500 over 10 years (the longest period they have). The correlation is almost dead-on.
That said, as I noted earlier in this thread, the S&P500 hasn't always beaten the average actively managed US equity fund. There were some lengthy periods, e.g. 1977-82 and 1991-93, when it was in the 3rd quartile.
Re TSE35 sectoral weightings, the big-5 banks represent 22% (plus a piece of Imasco which owns Canada Trust.) I don't have the weightings, but about half of the TSE35 look to be natural resource based. (OTOH, the TSE100 and especially the TSE300 have so many small and mid caps...)
Especially now with NAFTA, our heavy dependence on and correlation with the US economy suggests that Canadian index fund investments should be tempered with a good chunk of the S&P500.
Yup, indexing isn't a panacea (but it sure seems to come close.)
Your points are well taken.
Re: Minerals and Resources - I recall your argument on previous threads that this sector is not a good buy and hold. How do you account for the fact that their inclusion in the 100 means they have grown to be amoung the 100 largest public companies in Canada... over the long haul? That said, I still prefer the 35 for the dividends.
I won't dive into the size of funds argument on this thread, but if you beleive markets are efficient then the disclosure rules at 10% shouldn't be significant long term factor for large caps... just another tidbit of data to be shared efficiently. Another thread?
This thread continues...