It was a little disappointing to read Jon Cheavreau’s recent column in The Financial Post (See, Dynamic Funds leave index-hugging rivals behind, December 10, 2010). In the column, Mr. Chevreau praises Dynamic Funds for the many mutual funds that not only beat their peers but the index by a wide margin despite high MERs. Two of the funds in the list sport MERs higher than 4 percent. Performance fees are extra. Despite these sky-high fees, the funds handily beat the benchmarks. Take the Dynamic Dividend fund for instance. Over a 10-year period, the fund returned 7.7%. The TSX index returned 5.1%.

Mr. Chevreau who says he has imbibed the KoolAid of passive investing and exchange-traded funds asks if fellow index investors will eat crow along with him considering Dynamic’s past performance. My response would be that index investors have no reason to eat crow or any other bird. While index investing is based on the logic that investors as a group cannot beat the index, it doesn’t exclude the possibility that some mutual funds can beat the index some of the time, even over a period as long as 10 years.

If some funds can beat an index, why not pick those funds for your portfolio? The problem is picking the winning fund from among the thousands of mutual funds currently in existence before it starts posting market-beating returns. And the challenge doesn’t end there. You’ll also have to nimbly sell that fund before it turns cold (as most hot streaks are likely to, just ask Bill Miller) and buy another fund that is about to go on a hot streak. Needless to say, an investor’s chances of doing this consistently is pretty low.

Take the aforementioned Dynamic Dividend Fund. Yes, it has beaten the TSX composite over a ten-year period. But the fund was been in existence for more than 25 years. Extend the time period a little longer and the fund doesn’t appear so winning anymore. Over 15 years, it has returned 7.85 percent compared to 9.27 percent for the TSX. And over 20 years, the record reads 8.49 percent compared to 9.8 percent for the index. So, yes the Dividend Fund has beaten the index over 10 years but not over 15- and 20-years. To be honest, the performance over longer time frames is still respectable. But an investor considering Dynamic Funds back ten years ago might just as easily have picked a mutual fund from Trimark or AIC. Hindsight, as they say, is 20/20.

This article has 27 comments

  1. Like you say, show me the good funds ahead of time (or Bill Miller near the start of his streak) and I’ll invest in them.

    Until that happens, I’ll stick with my passive broad-based ETFs.

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  3. There’s no guarantee investors will successfully pick a winning fund. Past performance does not guarantee future return so like you said, it’s all in hindsight!

  4. And what is really unfortunate is that the masses read columns like Chevreau’s and eschew index mutual funds and ETF’s. Hard to believe that a guy like him could spread such a misinformed analysis.

  5. I recall a post from early days on the forum where Jon said the rest of us would know when he reached financial independence when he stopped posting on forums, etc. For me, that one comment diluted the value of all future comments from Jon. It was a reminder that some of us follow personal finance for a hobby, and some of us make a living from it. Maybe a bit harsh to cherry pick one comment, but that’s just the way it struck me.

  6. I find this situation similar to arguing against lottery tickets and being told “Well Bill Smith up the street just won $2000 in the Quick-Pick Deluxe — what do you think of that?!”

  7. Great counter article CC! One should always be weary when they see performance claims like this.

  8. I won’t be surprised at all if an unusually large number of Canadian Equity mutual funds, especially those of the dividend and income variety beat the TSX Composite over the past 10 years. After all, late 2000 was the time when Nortel was at its peak and dominated the indices. Any mutual fund that simply capped Nortel at 10 percent would have beaten the index over this carefully picked time period. It shouldn’t be terribly surprising that dividend and income funds, by virtue of their concentration in financials, which were reasonably valued in 2000, outperformed the benchmarks over 10 years.

    Let’s revisit these funds in another 5 years and take another look at their performance. If the record of other “market-beaters” is any indication, I don’t fancy Dynamic’s chances:

    http://www.canadiancapitalist.com/mackenzie-hits-back-at-etfs-part-2/

  9. Disclosure – I first recommended Dynamic Value Fund in 1994 (well before current manager David Taylor – whom I have a lot of respect for – took over) and continue to recommend it to clients. Obviously, I also own it myself.

    Frankly, I am surprised at CC’s response. I think Jon Chevreau is simply acknowleging that Dynamic is a company that is truly doing active management (most that claim they are, are index huggers) and they have had impressive results over the past ten years. That’s all I took from the article. Honestly, I thought Chevreau’s article was very fair and balanced in that he quoted advisors such John DeGoey who only espouses indexing. I certainly did not get the impression that Jon was suggesting he will, or anyone should, abandon passive indexing strategies.

    You guys seem personally offended that someone could have the gall to disagree with your indexing religion. Indexers love saying that the majority of active managers can’t beat the averages. This is true and easy to support with data. The fact remains that it is not hard at all to eliminate most of the crap out there and look for the few managers that are actively managing a portfolio and are able to demonstrate some talent and discipline. Certainly does not make it a sure thing, but it sure puts the odds in your favour, I believe.

    It must kill you guys to admit this, but there are a few good investment managers out there and they aren’t too hard to determine in advance (it certainly isn’t random) …. just like there are good and bad doctors, hockey players, blog writers, engineers, etc, etc.

  10. @Rob: I’ll concede that many indexing advocates, including myself, can come across as smug, though I wouldn’t say that we are offended by stories about successful active management. The problem is that we’re irritated that almost all of them, including Chevreau’s, imply (or state explicitly) that this outperformance could have been predicted or can be expected to continue. There is no evidence of that.

    I agree with many of your points, until you say that picking managers with talent and discipline “sure puts the odds in your favour.” It might improve your odds, but there is simply no way you can argue that any active manager can give you a better than 50-50 chance of long-term outperformance after costs.

    Neither does it make sense to compare talented money managers to talented hockey players or doctors, etc. The point isn’t that there are no smart, talented money mangers. It’s that being smart, talented and disciplined still cannot put the odds in your favor because the headwinds are too strong.

  11. @Rob: It doesn’t kill me to admit that there may be really good managers out there. I’m pretty sure that Warren Buffett for one is a very skilled active investor. For all I know, the Dynamic Managers might be among this group.

    There are two major points in Jon Chevreau’s article that I disagreed with: (1) Some of Dynamic Mutual Funds beating the averages over the past ten years somehow invalidates indexing as a strategy. (2) The Dynamic Funds’ past performance is a reason to pick them for the “explore” portion of a portfolio. I’m simply saying that Dynamic Funds’ outperformance doesn’t invalidate indexing and the past performance is no guarantee of future returns.

    I’ve heard the “filter out the index huggers” argument before. But I haven’t heard an explanation for how it is arithmetically possible for the non-index huggers as a group to beat the benchmarks. That’s because passive investors don’t beat the benchmarks. Index huggers don’t beat the benchmarks either. That means the non-index huggers in aggregate, by definition, are average and thus have the same return as the benchmarks (before expenses). That means there are winners and losers. Dynamic Funds is among the winners. Where are the losers?

  12. Great conversations! Whether you are pro index or pro active management, this is a case of what I call “Snapshot performance” or more commonly known as end date bias. Here’s an old article I wrote on the topic http://www.wealthwebgurus.com/article/124/snapshot-performance.aspx

    Here’s three key rules to remember:
    1. All it takes is one superb year to make a 10 year number look good
    2. Different end points can tell very different stories
    3. A 10 year return tells you where you ended but it does not tell you how you got there!
    Jim

  13. @couch – “there is simply no way I can argue that you have better 50-50 chance….” Are you kidding me? Of course one can argue that. And comparing to hockey players etc is completely valid. Having interviewed active managers over 20 years has proved that to me anyway. In both cases, it is so easy to predict the crappy stuff and it is very easy to pick out the scenarios where a manager is good. I concede the vast majority of active managers are garbage and maybe that is why you want to index. It makes sense to me for you, but I stand by my comments

    @cc I didn’t read that indexing was invalidated in the article but I’ll read it again. As for your “where are the losers?” question at the end of your response, they are everywhere. 95% are complete crap

    @yin. I agree end date bias is important to recognize when judging stats but I don’t think the dynamic has been inconsistent. Rather, they have been very consistent – don’t think your snapshot comment applies

    But in all three case it is just my opinion – but I certainly stand by it

  14. @Rob: Comparing skilled hockey players to skilled money managers makes no sense. Outperformance in hockey persists over long periods because there is a negligible amount of luck involved. If I played in the NHL this year, the chance of Sidney Crosby outscoring me is 100%. In fact, I would score zero points (well, I might tip one in on the power play) and the outperformance will likely be infinite.

    Investing is nothing like this. The chance of an index fund outperforming one of your star managers (after costs) in any given year is quite high, because most investment returns come from simply accepting market risks (beta), which requires no skill. When you pick a manger you think is skilled, all you can hope is that he or she can add some alpha at the margins.

  15. @Rob

    “It must kill you guys to admit this, but there are a few good investment managers out there and they aren’t too hard to determine in advance (it certainly isn’t random) …. just like there are good and bad doctors, hockey players, blog writers, engineers, etc, etc.”

    This is where your argument falls apart. Doctors, hockey players, writing, engineers all have a skill set that is measurable. It is possible to detect in advance who is doing well and more importantly detect when they start doing badly. In addition, for doctors and engineers, there are even laws in place to protect consumers against those who perform poorly and even dangerously. To suggest otherwise, is misleading and this is the source of the criticism for Chevreau.

    There is nothing like this for fund managers. You say that “they aren’t too hard to determine in advance” but you provide no means to do it. We can’t even measure Warren Buffet in any way that would allow us to predict the future performance of his company. Your only claim is that you personally somehow have the experience to pick the best fund managers. But unless you can provide the method and some evidence to back this up then no one can really give it any weight. I find it particularly hard to give your claims weight since you also sell these fund manager picking services.

    The last issue is how do you measure if the added benefit of the manager is worth more than the 4% yearly MER they are charging, in the case of some Dynamic funds.

    I am starting to really think that financial advisers should be a professional order.

  16. I understand that it can be hard to accept my belief in my ability to weed out crappy managers. I wouldn’t claim it if I didn’t believe it. I find it interesting that you think this is so difficult. I doubt I will convince you, and I am sure I won’t be convinced in the posts based on what I have seen so far. Probably just have to disagree on this.

    I also am able to access to these managers for one on one meetings when I need it – this isn’t available to most DIYers.

    Personally I tend to screen out anything with an mer over 2.5%, so the other funds mentioned in the article I have unfortunately avoided. I stand by that screen though because it has always worked well for me.

    The best thing I have ever seen written about what I am talking about is a chapter called “winning the active management game” in David Swenson’s book. Swenson supports indexing so you guys can safely read it, but the chapter is worth the time for anyone looking for active strategies for a portion of their investments.

    I think I have suggested this to cc a few years ago – maybe he can find it if he has it.

  17. Swenson’s book is here
    http://www.amazon.com/Unconventional-Success-Fundamental-Approach-Investment/dp/0743228383
    But if you can buy through cc’s site he receives a referral fee so do it that way since you heard about it here

  18. @Rob: Fair enough. I’m happy to leave it at that. I have written about Swensen’s chapter on how to go about picking an active fund:

    http://www.canadiancapitalist.com/how-to-pick-a-winning-mutual-fund/

    That chapter comes from the annual report of a well-respected mutual fund available here:

    http://www.longleafpartners.com/pdfs/98_q4.pdf

  19. You make some very important points. Using past performance will lose out to high fees in the long run. I believe you have added credibility to my argument that most investors should not invest in mutual funds. Please read my article “Why Stocks & ETFs, but NOT Mutual Funds”: http://tinyurl.com/2bhhgex

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  21. @Rob: No one doubts your ability to weed out poor managers or identify skilled ones. The point is that having skill is not enough to outperform the market on a consistent basis. You invoke Swensen, but you seem to have ignored his conclusion:

    “Even after identifying an extraordinarily talented team willing to act in investor interest by pursuing superior returns, a harsh reality intrudes. The standard prospectus boilerplate language defines the problem: “Past performance provides no guarantee of future results.” People change. Markets change. Circumstances change. Even with all the stars properly aligned, the most carefully considered decisions sometimes prove wrong.”

  22. @Canadian Couch Potato: Perhaps you and I use some of these terms differently, but I doubt people’s ability to find skilled managers in the sense that I doubt their ability to find a manager who is likely to outperform appropriate benchmarks in the future. If by “skilled” and “poor” you refer to past performance, then I agree with what you said.

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  24. Remember Altramira ? Goodman break the rules….Value fund buys none value Eq’s ,sells before end of Q…makes Dynamic (over 200) funds look good…after all BNS wouldn’t buy a dog…..Advisers love the big F.E.’s……carry on

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