The case for low cost passive investing

I’ve been in the financial industry for 20 years and I’ve done a lot of investment research over the years. What I have found is the whole financial industry is biased to selling high cost actively managed investments with the goal of being above average. Experts are constantly flaunting their great stories or sexy ideas to make lots of money or their strategies to beat the market. But does it really work?

It’s a ‘relative’ world

Relative performance is simply looking at the performance of a fund and comparing it to the performance of other funds. Two of the most common relative benchmarks are the index comparisons and peer group (average) comparisons.

Comparing to the peer group

When looking at the average, it is very important to compare apples to apples and oranges to oranges. For example, when you are comparing the performance of a Small Cap Canadian Equity Fund to that of an international equity fund or a foreign bond fund, you are comparing completely different investments.

Instead, you should take a look at the fund you own and then compare it to other funds of the same type. Theoretically, if you take a group of funds like the Canadian Equity funds, half will be above average and half will be below average.

Index comparisons

The other approach is to look at a fund category and compare it to the appropriate index.

Last year, the TSX lost 8.7%. If you had a Canadian Equity investment that lost less than -8.7%, then those in the financial industry would say, it did well on a relative basis. The data suggest that not many Canadian Equity Funds did well comparing against the index. In fact, only 27% of funds were able to beat the index:

Out of 580 Canadian Equity Funds with a 1-year track record (as of Dec 31, 2011),

  • Only 156 Canadian Equity Funds beat the index (-8.7%)
  • 177 Canadian Equity Funds beat the iShares TSX Index

We can do the same analysis looking at 3, 5 and 10 year periods (Snapshot performance to Dec 31, 2011):

177 Canadian Equity Funds with a 10-year track record

  • Only 6 beat the index (7%)
  • Only 12 beat the iShares TSX Index
  • Only 55 beats 5%
  • 6 of the top 20 funds were low-cost passive index funds

305 Canadian Equity Funds with a 5-year track record

  • Only 8 funds beat the TSX index (1.3%)
  • Only 11 funds beat the iShares TSX Index
  • Only 44 funds had positive 5-year returns

448 Canadian Equity Funds with a 3-year track record

  • Only 40 funds that beat the index (13.2%)
  • Only 54 funds that beat the iShares TSX Index

The longer the time frame, the fewer investments beat the index.

My two cents

This data may be overly simplistic but I have done this simple comparison many times over my 20 years in the investment industry. The figures may be slightly different at different times but the conclusion is always the same.

Most funds have a tough time beating the benchmark index over any period of time in any market environment. The data suggests that a winning strategy is a low-cost passive approach to investing. In fact, Academic research has proven over and over again that it is really difficult to time the markets and essentially ‘predict’ the future with any degree of accuracy which is why there has been a proliferation of low cost, passive investment strategies that don’t try to beat the market but rather replicate the market.

What do you think? Do you have any evidence that active managers can beat the index more often than not?


  1. Juan

    Lost cost investing really can be the safest way to go. I know many people who try to beat the market, but it just ends up with lots of transaction fees and few gains.

  2. Silvio Stroescu (ING DIRECT)

    Great post Jim. We need more index champions in Canada. Love your challenge towards evidence for active managed funds. After all, these funds charge higher fees and have an accountability to show the value added by the “active” approach. Having said that, I have yet to see any evindence in favor of active management success in the long term (comparing oranges to oranges) in my 15 years in this industry. Keep educating! Cheers

  3. mouse

    “Last year, the TSX lost 8.7%”…
    hmm, if I go to Yahoo charts for ^GSPTSE, I get -11.07% from Dec 31 2010 to Dec 30 2011.

    I believe Yahoo is giving me the “price” version of the index, right?

    So you are using the “total return” version (which includes dividends in addition to capital appreciation), right?

    If so,
    1. it’s probably important to point out in your (excellent) article that total returns are being considered
    2. where would I go to get total return TSX data??


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