The Power of Index Funds:
Canada's Best-Kept Investment Secret
by Ted Cadsby • Stoddart Publishing, 1999 • ISBN 0773760830

Index Funds is written in the same conversational style that was popularised by David Chilton in The Wealthy Barber. While some may object to this style, in my opinion it works quite well. This is a book without the jargon and endless references to obscure academic studies that one finds in most books on investing. While the book's primary appeal will be to beginning investors, Cadsby's arguments will ring true with more advanced readers who perhaps have seen some of them before in magazine articles or newspaper columns.

The case for indexing is actually even more compelling than what's presented in Index Funds. That's because Cadsby uses index returns minus an MER of 0.90% as his benchmark. (CIBC's index funds charge a 0.90% MER.) But in reality it's possible for individual investors to run index portfolios for much less using competitors' index funds. For instance Altamira and Royal charge 0.50% for most of their index funds. And one can also use Index Participation Units like the new S&P/TSE 60 iUnits or the US S&P 500 SPDRs which charge less than 0.20%. Even CIBC rebates their MERs down to 0.30% for accounts that hold at least $150,000 in their index funds.

In discussing how difficult it is to distinguish skilled fund managers from lucky ones, Cadsby uses the oft-cited example of 1,000 people flipping coins. After 10 tosses it's likely that at least one person will have flipped 10 heads or 10 tails in a row. But this is the result of luck, not skill. Cadsby then uses this logic to contend that it's possible for 10% of all mutual funds to beat the average fund's returns for three consecutive years due only to chance. Then he adds the coup de grace: "Given a sample size of 1,000 [fund managers], there is some consensus that it would take around 25 years to be able to conclude that a manager is likely to be talented, rather than just lucky. Even then we're talking about a higher probability -- not a certainty." Who needs those odds?

Yet despite this analysis Cadsby argues that indexing doesn't work for certain asset classes like small caps, and in Pacific Rim and "emerging market" countries because the markets on which they trade are less efficient than the large cap markets in North America and Europe. The inefficiency may be true, but it's not the only criterion. Trading costs (brokerage fees, bid/ask spreads, securities taxes and the like) are also much higher in these markets. Other indexing proponents like Malkiel and Swedroe argue that any edge an active manager may have in a less efficient market is more than offset by those higher costs. Cadsby on the other hand concludes that it's better to use actively managed funds in these classes.

While I don't agree with everything Cadsby says there's far more here to agree with than there is to quibble over. If Cadsby fancies himself as Canada's answer to John Bogle then to be sure, this book lacks the passion of a book, essay or speech from Saint Jack. If you've read Malkiel or any of Bogle's works then you won't find a lot of new material about indexing here. You will however find material that's oriented to Canadian investors. And if you're not familiar with indexing or you aren't convinced of its superiority then this book is certain to make you rethink how you invest.

Reviewed by Bylo, 17Nov99