Investment Commentary – March 2013

Active vs. Passive From a Canadian Perspective

Readers of our regular investment commentaries may recall that last January we devoted some time to writing about the recent struggles of active managers. While the past few years have certainly been tough on the investment management industry, the debate over active versus passive strategies has actually spanned several decades. For every fund with a strong track record, there are numerous studies that call into question the efficacy of active investment approaches. These studies argue that little can be gained from trying to beat the market, especially once fees and expenses are taken into consideration. This sentiment has undoubtedly played a role in the rising popularity of low-cost, passive ETFs.

However, there are signs that the demise of active managers has been greatly exaggerated – at least in terms of the Canadian investment landscape. The latest Active Manager Report released by Russell Investments Canada had some surprising results, with 76% of active fund managers in the Canadian Equity Large-Cap Universe outperforming the S&P/TSX Composite Index in 2012. This was the strongest performance relative to the benchmark in a decade. More importantly, the median manager return was more than 2% above the index, suggesting that even after deducting fees and expenses, an active strategy could have added value. The year was all the more impressive for funds focused on smaller Canadian companies, with the median small-cap manager posting a return of 8.9% versus a 2.2% decline for the S&P/TSX Small Cap Index.

These results were also not limited just to equity markets. With the Canadian bond index generating the lowest calendar year return since 1999, 95% of active managers in the Mercer Canadian Fixed Income Pooled Fund Survey outperformed in 2012.

For Canadian investors, the merits of active management stems from better diversification. A passive Canadian equity index fund can at times be woefully undiversified, with close to 50% allocated to Energy and Materials stocks. Active managers, on the other hand, tend to build much more robust portfolios from a risk/return perspective. In fixed income, a passive investment would currently have more than 40% allocated to low-yielding government bonds, which potentially face steep declines once interest rates begin to rise in earnest. In response, many active managers have broadened their exposure to higher-yielding corporate credit along with bonds with less interest rate sensitivity.

At T.E. Investment Counsel we believe that it is possible for talented active managers to add value over time. As we have seen, active managers can not only generate higher returns relative to the benchmark, they are also able to construct portfolios that mitigate some of the risks inherent in index funds. However, passive investing certainly has its advantages; namely, lower management fees and better results over certain time periods. The good news is that the choice between active and passive approaches is not mutually exclusive. Blending styles in a portfolio can draw from the advantages of both, potentially generating better performance and lower fees relative to the extremes. ETF providers have taken notice. After years of offering low-cost products that track an index, a new set of actively managed ETFs are becoming available to Canadian investors. As the saying goes, if you can’t beat them, join them.

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These articles are for general informational purposes only. Please obtain professional advice before taking any action based on this information. No endorsement or approval of any third parties or their advice, information, products or services should be implied by any references to third parties contained in any article. Trademarks cited in these articles are the respective properties of their owners.

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