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The Companion Advisor:
Investing in Mutual
Funds Active Investments - A necessary ingredient There's a common belief among investors that because the median performance of fund managers closely tracks stock market indices, it's better to buy low-cost index funds. What's the point of paying someone to actively manage their portfolios, when the returns are no different than the benchmark? In fact, these beliefs are based on various misconceptions.
Cheerleaders for index funds put their faith in the "efficient market theory"; which holds that stock markets always price individual stocks efficiently. Everyone has the same information on a company and interprets and reacts to it in the same rational way - so there's no value in active management. Yet we all know that investor behavior is as varied as investors themselves. They come in different ages and wealth brackets and have differing levels of knowledge and risk preferences. Not all investors will interpret information in the same way.
In addition, the safety and investment efficiency of holding a broad index is simply an illusion. Market indices like the S&P/TSX Composite Index Total Return can be overly dominated by one stock (as with Nortel in 1999) or by one sector (like energy stocks today). So when Nortel represented a third of the value of the TSE 300 index, approximately 36.5%* of index investors' portfolios were essentially concentrated in one stock - something that goes against the very fundamentals of investing diversification. The academic researchers supporting index investing have the luxury of picking the start and end points for their analysis. Naturally, hindsight is blessed with 20/20 vision. From 1982-2000, investor optimism prevailed - the Cold War ended, while new technologies and speculative ventures emerged to spark the imagination of the investing public. Companies were rewarded with hyped-up price-to-earnings multiples that resulted in stocks trading at prices well beyond their intrinsic worth. Anyone investing in the S&P 500 Index in 1982, who sold just before March 2000, would have made a respectable 12.4% per year (on an inflation-adjusted basis). So it's no surprise the academics and mutual fund activists who support passive investing use this bull market as the basis for their projections into the future.
But let's take a reality check. Just how many investors predicted that 1982 was the final trough between two long bull markets? How many truly had the discipline to get 100% invested and stay that way for the next eighteen years - and then sold everything in March 2000? We all know how few investors have the discipline or the foresight to buy early in a bull market and resolutely hang on through periods of market fluctuation. In fact, market turnover is on the rise. In 1960, the average holding period by investors was eight years. Today it is less than a year.
Going back to the importance of start and end dates, the passive investor who bought the S&P 500 Index five years ago would have negative returns today. The same investor who bought in ten years ago would now only be breaking even. Investing in an index fund can be dangerous to your wealth because in the real world, timing the market is impossible.
At Dynamic TM, we've been in this industry for almost 50 years and have seen trends come - and then go. When it comes to money management, there's no substitute for discipline and hard work, which is how our active approach has delivered solid returns to investors. We continue to outpace the average and median portfolio manager, with a number of our funds consistently adding value over their indices on a 1-, 3-, 5-and 10-year basis. Remember that economic and market forces are always shifting. Backward focused index investing doesn't manage change. At Dynamic we respect the past but we look to the future, and our management team has proven that professional active management is the key.
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, Fiscal Agents Money Management Newsletter
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