2018 Mid Year SPIVA Report

November 20, 2018

The mid-year 2018 SPIVA report on Canada is available.  It paints a damaging picture for active managers.


Active investment management attempts to outperform the market return through superior research, analysis and tactics.  Passive managers attempt to replicate the return of the market by owning every security in the market at its market weight.  “Passive” is a word with negative connotations.  This is not the case in the context of investing.  Passive investing is synonymous with index investing.


The theory states that passive investment management always outperforms active investment management over any time-period after-cost.  The theory is sound.  A market capitalization index return is the weighted sum of the return of all index components.  Passively invested participants invest in index components exactly in their market weight.  Passive participants don’t over or underweight any component.  Stated differently, passive investors do not act on an investment opinion of any of the individual market components.  Passive investors receive the market return before cost.


Actively invested participants do hold and act on investment opinions and choose which market components to over and underweight.  But, the group of all active participants must hold each market component in its market weight.  Each market component has a finite number of shares outstanding.  If one active participant overweights a component, it is certain that at least one other active participant underweights the same component.  From this follows that some active participants will outperform the market return, but this is exactly offset by other active participants that underperform.  The group of all active participants average the market return pre-cost.


Another certainty is the cost to offer active management is higher than the cost to offer passive management.  High priced fund managers, research analysts, traders and others must eat (and they eat well).   It follows, then, that after cost is extracted the group of passive participants always outperforms the group of active participants.  This will remain true as long as active investment management is more expensive than passive investment management. 


If you want to read the same from a Nobel prize winning economist, please read the first two pages of William Sharpe's 1991 article.


SPIVA stands for S&P Indices Versus Active.  Their mandate is to measure the performance of actively managed funds against their relevant S&P benchmarks.  The data reinforces the theory.  The data is extracted from Report 1: Percent of Active Funds Underperforming Index and Report 4: Asset-Weighted Fund Returns. 


Report 1 tells us that 89% of Canadian Equity funds underperformed the S&P/TSX Composite over the 10-year period ending June 30, 2018.  Report 4 tells us that the S&P/TSX Composite had a 10-year average annual return of 4.24% to June 30, 2018.  Canadian Equity funds averaged 3.75% over the same time-period.  This is a .49 basis point annual underperformance for 10 years by Canadian Equity funds.  This is better than expected and more on this below.


98% of U.S. Equity funds offered by Canadian firms for Canadian investors underperformed the S&P 500 with currency conversion.  The S&P 500 (Cad) had a 10-year average annual return of 13.0% to June 30, 2018.  U.S. Equity funds offered by Canadian firms and after conversion into Canadian dollars averaged 9.7% over the same time-period.  This is a 3.3 percentage point average annual underperformance per year over the last 10 years.


95% of International funds (non-north American investments) offered by Canadian firms for Canadian investors underperformed the S&P EPAC LargeMidCap with currency conversion.  The S&P EPAC LargeMidCap (CAD) had a 10-year average annual return of 6.29% to June 30,2018.  International equity funds offered by Canadian firms and after conversion into Canadian dollars averaged 3.65% over the same time-period.  This is a 2.64 percentage point annual average underperformance per year over the last 10 years.


The underperformance has consequence.  An equally weighted growth portfolio without rebalancing (not recommended) of 33.3% each in Canada, U.S. and international grew by an average annual return of 5.7% over the last 10 years.  The same weighted portfolio of indices grew at 7.8%.  As seen here, a 2.1 percentage point difference has consequence; especially as the time-period grows.


With the advent of low-cost, broad-market, passively managed ETFs, a Canadian investor can get access to the market return in these markets for a total portfolio cost well under 10 basis points.  Had they done this 10 years ago they would be looking at an approximate 7.7% average annual return, two full percentage points above the 5.7% likely received.


Note that the underperformance of Canadian equity funds versus the benchmark seems small.  This is largely explained by the fact that most Canadian equity funds have a small but consistent foreign, mostly U.S., component in their funds.  This is reasonable.  There are too many sectors that are unrepresented or underrepresented by Canadian companies.  There is no Canadian car manufacturing company for example.  It would be more accurate to benchmark most Canadian equity funds off a blended index.  A 92% S&P/TSX Composite, 8% S&P 500 (CAD) for example, would be a more appropriate benchmark than 100% S&P/TSX Composite benchmark.


Thanks for reading and let us know what you think.





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