The following table compares the compounded annual returns (CARs) for the last 15 years between portfolios comprised of the median (half did better, half did worse) actively managed funds versus similarly weighted portfolios of index funds.

	1	2	3	4	5	6	7	8
Asset Class	Index	Active	I-A	Margin	I-MER	I-MER-A	Margin	15-yr Diff
	no MER	with MER	diff	diff/Active	0.5% MER	diff	diff/Active	(diff)^15
TSE 100 TR - Canadian Equity	10.9	10.0	0.9	9.0%	10.4	0.4	4.0%	6.2%
SCM Bond Universe - Can Bonds	10.1	9.0	1.1	12.2%	9.6	0.6	6.7%	9.4%
S&P 500 - US Equity	13.5	12.0	1.5	12.5%	13.0	1.0	8.3%	16.1%
MSCI EAFE - International Equity	10.3	9.0	1.3	14.4%	9.8	0.8	8.9%	12.7%
increasing Canadian Equity
20/40/20/20	11.0	9.8	1.2	12.0%	10.5	0.7	6.9%	10.7%
30/40/15/15	10.9	9.8	1.1	11.6%	10.4	0.6	6.5%	9.9%
40/40/10/10	10.8	9.7	1.1	11.1%	10.3	0.6	6.0%	9.1%
increasing US Equity
20/40/20/20	11.0	9.8	1.2	12.0%	10.5	0.7	6.9%	10.7%
15/40/30/15	11.3	10.1	1.2	12.1%	10.8	0.7	7.2%	11.4%
10/40/40/10	11.6	10.3	1.3	12.2%	11.1	0.8	7.4%	12.0%
increasing Global Equity
20/40/20/20	11.0	9.8	1.2	12.0%	10.5	0.7	6.9%	10.7%
15/40/15/30	10.8	9.6	1.2	12.4%	10.3	0.7	7.2%	10.9%
10/40/10/40	10.6	9.4	1.2	12.8%	10.1	0.7	7.4%	11.0%

[Returns data is from the Financial Post's 15-year mutual fund review for the period ending 31Dec00 (published 08Feb01.) Benchmark returns include reinvested dividends.]

Column 1 shows pure index returns, i.e. without allowing for management expense ratios (MERs.) This is a theoretical rate of return that can be achieved only if all costs are eliminated.

Column 2 shows the performance of the median actively-managed fund or fund portfolio.

Column 3 indicates by how many percentage points each year a portfolio of indexes outperformed an equivalent actively managed portfolio, i.e. Col3 = Col1 - Col2.

Column 4 expresses this annual outperformance as a percentage (margin) over an actively managed portfolio, i.e. Col4 = (Col1 - Col2)/Col2. A value of 13.2% means that the margin by which the indexed portfolio outperformed represents 13.2% of the actively-managed portfolio's annual return.

Column 5 shows the annual performance of a portfolio implemented with index funds after allowing for an average MER of 0.50%.

Column 6 indicates by how many percentage points each year an indexed portfolio outperformed an equivalent actively managed portfolio, i.e. Col6 = Col1 - MER - Col2.

Column 7 expresses this annual outperformance as a percentage increase (margin) over an actively managed portfolio, i.e. Col7 = (Col1 - MER - Col2)/Col2. This is similar to Column 4 except that it accounts for MERs.

Column 8 shows the total additional returns that an indexed portfolio achieved over the 15 year period compared to an actively-managed portfolio.

Following the data for the individual asset classes is data for typical portfolios. The aa/bb/cc/dd indicates the percentage weightings respectively in Canadian equities, Canadian bonds, US equities and Global equities. The typical Canadian RRSP-eligible balanced fund (median 15-yr CAR ~9%) has a 40/40/10/10 composition.

One should be hesitant to draw any strong conclusions from just 15 years of data since that's a relatively short period to study. But that's all the data generally available for Canadian mutual funds. This hesitation is especially important considering that the past 15 years have seen (a) a sustained reduction in inflation and interest rates, and (b) the greatest bull market of the century in the US. How long can this continue?

That said, the approximately 1 percentage point annual outperformance of indexed portfolios is striking. This represents an approximate 10% margin of outperformance over actively managed funds. Given the powerful effects of compounding over long time periods, even an annual advantage of 1 percentage point is significant.

Why these numbers are biased against indexed portfolios:

1. The 0.50% MER "handicap" imposed on the index portfolios is at the high end of the range. Most investors can reduce the effective MER using a hybrid of Exchange-Traded Funds (ETFs like XIUs and SPYs), low-MER index funds and in the case of fixed income, bond ladders. Those with more than $150K can reduce the total MER to 0.30% or less using CIBC index products, either exclusively or in combination with ETFs.
2. The 15-year numbers for actively-managed funds are inflated due to survivorship bias. Many of the poorest performing funds no longer exist so their sub-par performance no longer drags down the averages. It's difficult to assess how much an effect this has, however, most academic studies have found that survivorship bias can inflate the compounded annual returns of surviving funds by several percentage points.
3. In some asset classes the number of actively-managed funds that have existed for a full 15 years is quite small.
4. In taxable accounts the indexed portfolios will do much better on an after-tax basis due to their generally lower turnover. Again it's hard to assess how much of an effect this has. And of course in RRSPs this is not an issue.

1. Generally speaking, low-MER actively-managed funds outperform similar high-MER funds. How much would the results differ if we excluded the high-MER funds from the fund averages?
2. Studies have shown that one derives a "rebalancing bonus" by periodically selling the better performing asset classes and using the proceeds to buy more of the laggards. This bonus can add an annual performance improvement of 1% or more. The comparison makes no provision for rebalancing. (The benefits of rebalancing can be better realized inside tax-sheltered retirement accounts like RRSPs.)
3. Returns are only one dimension of portfolio behaviour. An investor's ability to sleep well during the inevitable market downturns is also important, however the comparison does not address the volatilities (standard deviations) of the various portfolios.

1. Vanguard's John Bogle says, "costs matter." The above numbers provide strong evidence that this is true.
2. Small differences add up over time. A 1% improvement in a portfolio's annual return adds ~16% in total return after 15 years. And thanks to the power of compounding, that advantage grows to 22% after 20 years, 35% after 30 years and 49% after 40 years! (A 2% annual advantage grows from 34% after 15 years to a whopping 120% after 40 years.)
3. For "typical" asset mixes one could achieve ~10% compounded annual returns over the past 15 years. (40% in bonds may not be "typical" for everyone but it is typical of many balanced funds.)
4. A simple RRSP-eligible portfolio of actively-managed funds (40% Canadian equities, 40% bonds, 10% US equities and 10% global equities) seems to beat the average Canadian balanced fund by ~1% per year. An indexed version of the same portfolio wins by an even wider margin.

15 years ending 30Jun00
15 years ending 31Dec99
15 years ending 30Jun99
15 years ending 31Dec98 and  In Defense of Index Funds