# Why actively managed funds under perform



## CrazyMorgan426Hemi (Dec 27, 2020)

I keep on reading that actively managed mutual funds can never beat the index over a long period of time as the fund manager(s) can never beat the market. This is why Canadian Couch Potato (and many other sources) suggest investing in ETFs or passively managed mutual funds. I however found two funds (TDB972 and TDB977), and they were created in 1987 and 1986 respectively. Since inception, both these funds have a performance of 8.71% and 8.36%. I compare this to the Vanguard funds that Canadian Couch potato suggests (VCIP, VCNS, VBAL, VGRO) and they have an inception performance of: 8.45%, 6.21%, 6.57%, 6.84%.

I also do realize that the TDB funds and Vanguard funds are probably invested in different industries. This question stems from after talking to a financial advisor, and he proposed TDB972 and TDB977 as an argument against the fact where mutual funds never outperform the index in the long run.

My question is why do a lot of sources recommend not going with an actively managed mutual fund when TDB97 and TDB977 have beaten VCND, VBAL, and VGRO by almost 2%?


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## james4beach (Nov 15, 2012)

CrazyMorgan426Hemi said:


> My question is why do a lot of sources recommend not going with an actively managed mutual fund when TDB97 and TDB977 have beaten VCND, VBAL, and VGRO by almost 2%?


It's possible for some active managers to outperform the index, it's just very rare.

TDB977 is a 100% US equity fund, so you have to compare it to an American equity index. That means the S&P 500. The 15 year return of this fund shows that it's beaten the index by 0.5% per year (not near the 2% you mentioned).

Beating the index by 0.5% annually over 15 years is good. The fund manager, Larry J. Puglia, has done a very good job.

So now you have to ask yourself how long he can keep working his magic. The fund manager is 60 years old. How long do you think he will keep working in this role?

These Morningstar analysts write that they have _downgraded_ funds he manages because: "Puglia, 60 years old in 2020, has not set a date, but is likely to retire within the next two years."

Once they change managers, all bets are off. *Most* active managers underperform. So if you buy into a fund managed by a 60 year old guy, the odds are that you will have a new fund manager soon, and the odds are that the new fund manager will underperform the index.


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## milhouse (Nov 16, 2016)

Yes, actively managed investing can beat a passive investing approach but the successes are rare, particularly in the _long term_ because of the compounding drag from higher fees and changing trends. 

Most actively managed funds will not be able to outperform a passive approach over the _long term_. How do you select what the winners will be in the future since past performance is not a guaranteed indicator of future performance? I suppose you can go with the funds you mentioned but there's no guarantee that they will outperform in the future. And I'm sure some keeners will be able to pull up quite a few examples of funds which way outperformed for a decade or 2 and then flamed out the next decade. 
Also keep in mind there is a multitude of funds that have been discontinued because they have underperformed and/or there is no interest in them. So the odd of picking the right actively mutual funds that will outperform over the long haul is like picking a needle in a haystack. Over the short term, it's more possible to pick a "winner" (even if due to luck) but the diffulty is choosing correctly again repeatedly over many years.
Secular trends change. We've been in a falling interest rate environment for the last 30+ years which propped up bond returns and dividend strategies. Who knows how and when things will change with rates start to rise which people have been talking about for the last decade.

Make sure you are comparing apples to apples because asset allocation will influence results. I don't know if it's fair to compare a 100% equity fund vs say a 50:50 index portfolio over the long term since equities will always eventually outperform bonds over time (10-15yrs at worst).
The all in one Vanguard funds you refer to are only about 3 years old and unfortunately, that's not a long enough time frame for comparison. Nor is comparing their past 3 year performance since inception versus both the mutual funds peformances over their past 3 years (not long enough time period) and their performance since their inception in the late 80's (how is it an accurate comparison to allow the mutual funds to factor in gains from previous years but only the past 3 for the ETF's?).


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## james4beach (Nov 15, 2012)

milhouse said:


> Make sure you are comparing apples to apples because asset allocation will influence results.


Over the years, as I've looked into claims of this fund or that outperforming the index, I've found that most of them really are not outperforming when the comparison is done properly. The time frames might be short, or not even align. Or they are being compared to different allocations, not apples to apples.

TDB972 is nearly 100% Canadian equities and has actually *underperformed* the TSX index over 5 years, 10 years, and 15 years! And by quite a bit actually.

TDB977 did actually outperform its index by 0.5% annualized, as I wrote above, but the fund manager is likely to retire at any moment. It's extremely unlikely that the outperformance will continue.


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## Money172375 (Jun 29, 2018)

I forgot most of what I knew regarding investing. I spent 3 years at TDAM. this Was back 2008-2011. Before fees became as discussed as they are now. Just adding some perspective. There was often talk about acknowledging performance, particularly against benchmarks. Ie. 972 not being benchmarked against the broader tsx index but against a weighted sector index and tsx 60. The fund managers goal is simply to outperform the stated funds benchmark. This obviously means nothing to the investor as they could often care less about what the benchmark is. That being said, most funds are designed to meet specific needs....so you can’t expect a dividend oriented fund to always (or even often) outperform the broader market. So, it can be said, that while most people may benefit from the broader market, there is a market for other funds to meet specific investing goals. Don’t know if they achieved it, but I would suspect that for some funds (ie. 972), they may admit to lower performance, but it may have lower volatility than the broader market. Perhaps someone smarter (or has better memory) can confirm this. Has 972 been less volatile than the broader market? I know this idea of lower performance, but lower volatility, was favoured by some, as they felt that Canadians would be more likely to buy and hold. They would rather have a consistent 4-6% vs. A bumpy, volatile ride that would net 8-10%. Truth being that they couldn’t stomach the volatility and would typically leave the fund before it rebounded.

towards The end of my time there, the idea of total return became more popular. Recognizing that some investors only cared about the final return, regardless of benchmark or volatility. 

it was a healthy debate at the time, which I thought was good.

in any event, I’ve switched mostly to passive investments....simply for the ease and cost. The cost really starts to be a consideration with larger dollars invested. When starting out though, it’s not much of a factor.


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## GreatLaker (Mar 23, 2014)

It's possible for actively managed funds to outperform, it's just that over long time periods, it is rare.

The Arithmetic of Active Management by William Sharpe proves how the average of actively managed funds invested must trail the market after costs. 
The Arithmetic of Active Management 


> To repeat: Properly measured, the average actively managed dollar must underperform the average passively managed dollar, net of costs.





> The best way to measure a manager's performance is to compare his or her return with that of a _comparable passive alternative_. The latter -- often termed a "benchmark" or "normal portfolio" -- should be a feasible alternative identified _in advance_ of the period over which performance is measured. Only when this type of measurement is in place can an active manager (or one who hires active managers) know whether he or she is in the minority of those who have beaten viable passive alternatives.




S&P Dow Jones Indices publishes SPIVA reports which document what portion of actively managed funds beat their benchmarks. Now to be clear, ETFs generally trail their benchmarks, but for most their costs are so low they easily beat most active funds. Here is the SPIVA Canada 2020 report and some excerpts and summaries:
SPIVA® Canada Mid-Year 2020 Report 


> *88% of Canadian equity funds underperformed their benchmarks over the past year, in line with the 90% that did so over the past decade.* This shortfall was not an outlier, as in six of seven categories, a majority of funds fell short of their benchmarks in the past year, and at least two-thirds of funds did so in every category over the past 10 years.





> Canadian Equity funds were particularly notable for their level of underperformance. On an asset-weighted basis, Canadian Equity funds returned a dismal 7.9% below the S&P/TSX Composite over the past year, the worst relative performance of any fund category.


SPIVA also publishes persistence reports that document how many top performing funds were able to maintain that outperformance over time.
Canada Persistence Scorecard: Mid-Year 2020


> For example, of the Canadian Equity funds that finished in the top quartile in terms of cumulative returns for the period from June 2010 to June 2015, only 8.3% finished in the top quartile for the period from June 2015 to June 2020. In fact, *it was more likely for a top-quartile fund to close its doors or change style (25% combined) than to remain in the top quartile.*



It's easy to pick funds that have good past performance; much harder to predict future results. There are some actively managed funds that have good long-term performance like Mawer, and some conservative equity funds from Canadian banks. I own some Mawer funds, but I would have a hard time putting all my retirement funds into any active fund or funds.

Your advisor is unlikely to recommend ETFs or funds from small companies like Mawer because they do not pay ongoing commissions.... which is how advisors get paid. There may be other ways he or she can add value, if they guide you on how to invest, or provide excellent planning and recommendations on other financial issues like insurance, RESPs for you kids, retirement planning advice etc. 

But the record is clear, that most actively managed funds underperform a relevant benchmark, it's difficult to pick good funds in advance, and funds that do very well tend to have performance that regresses to average or worse over time.


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## Covariance (Oct 20, 2020)

If I understand you are doing research to understand the validity of your advisors recommendations.

In this transaction you are paying two people. The advisor picking the fund and the fund manager running the fund.

As noted some active funds can outperform the benchmark (index) some of the time. This is rare, and even rarer for extended periods of time. The real question to your advisor is “what strategy is the manager of the fund following to produces these incremental returns?” You can decide on the quality of the answer. you are paying this advisor (in some fashion) for this advice so you might as well understand what their thought process is.

Re the fund itself. Without getting into the weeds. By definition beating the benchmark means buying stocks that become worth more, relative to the benchmark. The task is to identify that stock, and then buy it at the right time. You can see the challenge is three fold - pick the right stock and then buy it when it bottomed in price, and do this with multiple stocks of a combination that does not go down when the benchmark is going up. Again, the question to the fund manager is what is your process or strategy to pull this off?


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## CrazyMorgan426Hemi (Dec 27, 2020)

Thank you for your advice. Mutual funds definitely do not seem worth it when compared to an index fund. I have a few more questions about index funds:


 How does an index determine what funds get put into it?
 How to tell if a fund is actively or passively managed? Does a low MER (< 1%) indicate the fund is passively managed?
 Is there a website that contains a list of all passive ETFs and index funds?
 How would I determine which index a fund is following? For example, I want to compare ARKK with the index.


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## GreatLaker (Mar 23, 2014)

CrazyMorgan426Hemi said:


> Thank you for your advice. Mutual funds definitely do not seem worth it when compared to an index fund. I have a few more questions about index funds:
> 
> 
> How does an index determine what funds get put into it?
> ...


1) There are so many indices that it is hard to generalize. Some indices are entirely rules based, for example the Russell 1000 index holds the largest 1000 stocks in the USA by market capitalization. The S&P500 by contrast is rules based augmented by a decision committee. It is designed to reflect the performance of approximately 500 of the largest US companies. The committee reviews stocks by market capitalization, trading volume, sector classification etc to ensure it consistently reflects the largest US stocks. The TSX composite is also rules based augmented by a committee to reflect the largest Canadian Companies. For international stocks there is EAFE (Europe, Australasia, Far East) containing large and mid-sized companies in developed countries outside North America. There are also fundamental indices that look at profitability, growth, size etc. There are many many indices, to reflect almost any country, region, market cap, investment style, etc. Initially you should look to understand some of the common ones I named above.

2) Sometimes the word index will be in the name, like iShares Core S&P/TSX Capped Composite Index ETF (XIC). Other times you have to look at the fund description, like "Seeks long-term capital growth by replicating the performance of the S&P®/TSX® Capped Composite Index, net of expenses." Low MER is an indicator, but not absolute. If it's not in the fund name you need to look at its objective, which is documented on the website or prospectus

3) Not sure. Morningstar Canada and the Globe and Mail maintain fund databases, but I don't know if there is a list as simple as you want

4) It will either be in the fund name or description. But many active funds do not track indices. Mawer Canadian could be compared against the TSX composite, but does not seek to replicate its performance. ARKK is a true active fund that focusses on companies that create disruptive innovation. Dunno if there is a relevant index for that. Maybe a small cap index or NASDAQ. But it's likely to be very volatile and could go through long periods of high or low performance. Unless you are investing money you don't mind losing, funds like ARKK are risky.

www.Finiki.org is a good website for Canadian Financial info. Here is their portfolio design section. 
Portfolio design and construction - finiki, the Canadian financial wiki


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## AltaRed (Jun 8, 2009)

1) The question asked is 'bass ackwards'. The question is which funds track which index.

4) The OP needs to google the Fund Facts document or the prospectus for each of the funds of interest. How else can one understand the security they are potentially purchasing?


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## Money172375 (Jun 29, 2018)

AltaRed said:


> 1) The question asked is 'bass ackwards'. The question is which funds track which index.
> 
> 4) The OP needs to google the Fund Facts document or the prospectus for each of the funds of interest. How else can one understand the security they are potentially purchasing?


Average investor doesn’t even know Fund Facts or a prospectus exists. The industry is terrible about promoting them, especially the FF which were meant to simplify the basic required info.


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## AltaRed (Jun 8, 2009)

Money172375 said:


> Average investor doesn’t even know Fund Facts or a prospectus exists. The industry is terrible about promoting them, especially the FF which were meant to simplify the basic required info.


That does not excuse anyone from not exercising a bit of due diligence. Most buyers of new vehicles will at least check a few reviews and/or Consumer Reports before buying a vehicle. They probably spend more time reviewing specs on a new TV than they do a financial product, and generally would read labels in a supermarket before buying a product. Why should a financial product be any different?

The issuers of the products shouldn't need to promote any of the supporting materials as long as the documents are mentioned in their web pages along with links to the materials. That is the equivalent of the food label.


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## Covariance (Oct 20, 2020)

CrazyMorgan426Hemi said:


> How does an index determine what funds get put into it?
> How to tell if a fund is actively or passively managed? Does a low MER (< 1%) indicate the fund is passively managed?
> Is there a website that contains a list of all passive ETFs and index funds?
> How would I determine which index a fund is following? For example, I want to compare ARKK with the index.


1. Major index are rules based. The rules are available to read on the publisher of the index (not the fund). Eg S&P500 is an index which they determine with their rules a list of 500 stocks. Funds may follow this index by buying the stocks. 
2&4. The fund manager specifies its strategy and benchmark. If you go to their website look at fund facts. For example an index fund that is passive, tracking the S&P500 index, will state this. Now an active fund may say they seek to outperform the S&P500 by undertaking blaa blaa blaa (their strategy). They charge a (higher) fee to compensate their people employing this strategy. It shows up in the MER and other places. However looking at the MER is not a reliable indicator of strategy as some funds will describe an active strategy yet closely if not completely follow the index. They do this because they know people do not like wide deviations from the average performance, yet wish to beat it some how. This is known as closet indexing. It can detected through analysis of historical fund return versus the benchmark. As you might expect a closet index fund’s return will closely follow the index return. Yet the investor will earn less due to fees.


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## Earl (Apr 5, 2016)

CrazyMorgan426Hemi said:


> This question stems from after talking to a financial advisor, and he proposed TDB972 and TDB977 as an argument against the fact where mutual funds never outperform the index in the long run.


Past performance does not guarantee future results. Those funds outperformed due to luck, and there is no reason to believe they will continue to.


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