Despite a decade of dismal returns and high fees, Canadian investors remain disproportionately tethered to actively managed mutual funds.
The Canadian Active Management Paradox
As of late 2017, Canadian investors held a staggering 88.8% of their mutual fund and ETF assets in actively managed products. This stands in sharp contrast to the United States, where the shift toward passive indexing is much further along, leaving only 65% of assets in active hands. This Canadian preference for active management would be justifiable if these funds were delivering superior results. However, the data suggests that Canadian investors are paying a premium for a service that consistently fails to deliver on its primary promise: market-beating performance.
The semi-annual SPIVA Canada report, prepared by Standard & Poor’s, provides a sobering look at this reality. For the first time, the report includes a full decade of data, allowing for a long-term assessment of how active managers fare against their relevant benchmarks. The results are not merely disappointing; they are dismal. Across almost every asset class, the probability of an active manager outperforming the market is vanishingly small, yet the Canadian public remains deeply invested in these underperforming vehicles.
A Decade of Underperformance
The ten-year data ending in December 2017 paints a grim picture for the active investor. In the Canadian equity space, only 8.14% of mutual funds outperformed the S&P/TSX Composite Index. The figures for other categories are equally stark. In the Canadian Dividend and Income Equity sector, exactly zero percent of funds outperformed the S&P/TSX Dividend Aristocrats Index. When looking abroad, the story remains the same: only 1.67% of US Equity funds and roughly 6% of international and global funds managed to beat their respective benchmarks in Canadian dollar terms.
While it is true that an index investor cannot track a benchmark perfectly due to fees, the gap is a matter of scale. An index investor should only underperform by the small cost of the fund itself. In contrast, the average Canadian equity fund underperformed the index by 0.79% annually, while US and global equity funds trailed by more than 3%. These margins of underperformance are substantially higher than the cost of owning index funds, even when factoring in the cost of professional financial advice. For the average family, the math of active management simply does not add up.
The Illusion of Success
If the performance of these funds is so consistently poor, one might wonder why they remain so popular. The answer lies in survivorship bias. Banks and mutual fund companies do not display rosters of funds that have spent a decade trailing the market. Instead, they highlight the winners and quietly shutter the losers. The SPIVA data reveals that of the funds existing at the start of 2008, only about half survived to the end of 2017. Specifically, only 37% of Canadian equity funds and 50% of US equity funds remained in existence by the end of the decade.
This high mortality rate among mutual funds creates a distorted reality for the consumer. When a fund performs poorly, it is merged or closed, effectively scrubbing its failure from the current marketing materials. This allows firms to present a curated selection of 'survivors' that appear more successful than the industry is in aggregate. The consumer sees a landscape of seemingly healthy funds, unaware that they are looking at a graveyard where half the participants have already been buried.
The Myth of the Skilled Manager
Even for the tiny fraction of funds that do beat the index, there is little evidence that this success is repeatable. S&P’s persistence scorecard for US funds—a reliable proxy for the Canadian experience—shows that top-tier performance is almost never sustained. Of the top-quartile domestic equity funds in 2013, only 0.34% managed to stay in that top quartile four years later. In fact, the data suggests it is statistically more likely for a top-performing fund to drop to the bottom quartile than it is for them to maintain their lead.
This lack of persistence corroborates decades of academic research, including Mark Carhart’s seminal 1997 paper which concluded that the data does not support the existence of truly skilled or informed mutual fund managers. If outperformance were a result of skill, we would see managers consistently winning year after year. Instead, we see a distribution of returns that looks much more like a game of chance. For those who are already financially independent, gambling on a lucky manager might be a tolerable risk. But for the average person saving for retirement, taking on 'active risk' for such a remote probability of success is a gamble they cannot afford to lose.