Index funds v. actively managed
Jonathan Chevreau The National Post Tuesday, October 26, 1999
Author Ted Cadsby ruffles a few managers' feathers

Ted Cadsby's new book, The Power of Index Funds, has stirred up resentment among managers of broker-sold actively managed fund companies.

Except for the banks, most of the big load brand names in mutual funds don't even sell index funds.

Jade Hemeon, a spokeswoman for Trimark, says, "We believe active managers add value by being able to select stocks that don't necessarily duplicate the index but represent the best opportunities at the best price. Many index stocks are expensive at this point. Usually those things come into balance." And her viewpoint is typical among the brand names.

Don Reed, president of Templeton Management Ltd., believes his company's worldwide team of 180 fund managers and research analysts will beat indexes over the long haul. "We're long-term investors. If an index beats us any given year, it's no big deal." Its flagship Templeton Growth Fund has a 45-year track record and "has done reasonably well" compared with global indexes, he says.

Active fund proponents argue active managers can better ride out a bear market. Further, because active funds are accompanied by advice, there's less chance these funds would be jettisoned during temporary market turndowns.

While U.S. investors have embraced do-it-yourself investing, 85% of Canadians still prefer the "advice" channel in one form or another, says Dan Richards, president of Toronto-based Marketing Solutions.

He concedes that if the passive trend sweeps Canada, it could accelerate the separation of management from advice. Fund investors could end up paying 1.25% for active fund fees or as low as 0.25% for index funds, but they might pay a 1% annual fee on top of that for advice.

At the Fund Library discussion forum, one unequivocal advocate of indexing, who goes by the Internet handle of Bylo Selhi, insists "a well-diversified portfolio of low-MER, low-turnover index funds will, over the long haul, beat a similar portfolio of high-MER, high-turnover actively managed funds."

Another contributor says no one "is suggesting it is impossible to beat the index. Every year some funds beat it. The problem is determining in advance who will beat the index."

While Mr. Cadsby advocates blending active and passive management, there is a debate as to whether fund investors should avoid active management altogether. An academic paper of July, 1999, by professors at Wharton, Brown and the University of Pennsylvania (http://finance.wharton.upenn.edu/~metrick/nberap2.pdf) is not definitive.

In opaque mathematical language, it suggests that when particular active funds do beat indexes, mere luck may account for it. After examining the performance of almost 1,500 fund managers in 1996, it concluded "the average active fund underperforms index funds on a risk-adjusted basis. Skilled management, if it exists at all, is difficult to detect."

But the study's authors also concede it may be premature to jump to the conclusion that investors should avoid active funds altogether. They admit their analysis does not include elements of the investor's decision such as load fees and taxes. As Mr. Selhi puts it, "That's like saying if we didn't have to pay the fund managers, the sales channel and the tax collectors, well then maybe actively managed funds could beat their indexes."

The study's authors point out the truism that, despite the growth in passive investing, active management is still the dominant mode of investing in funds. There is, of course, a huge vested interest in keeping active investing: jobs for fund managers, huge marketing and advertising budgets for the media, commissions and trailer fees for the army of North American financial advisors that sell actively managed funds, etc.

But is what's good for a huge industry necessarily good for its customers? Another discussion insists "index fund advocates are wrong," amounting to a process of merely picking old winners.

Let's give the final word to the Internet's Mad Herbivore, who describes himself as an advisor who uses a blend of active and passive management.

"If index advocates are wrong, and I see no indication of that being the case, then they can't be very far wrong, when one considers the tax efficiency, 1% to 2% annual fees savings and liquidity of index investing."

 

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