Wednesday, February 4, 2009

Mutual Fund Scorecard

Standard & Poor’s Indices Versus Active Funds Scorecard (SPIVA) is out. For the fourth quarter of 2008, 53.2% of actively-managed Canadian equity mutual funds beat the TSX composite index.

Some will tout this as a sign that you need active fund management for protection during down markets. We need to dig a little deeper to see the truth. To begin with, 53.2% is such a narrow victory that it is better to think of it as a tie.

The next thing to look at is how this slim majority of actively-managed mutual funds beat the index. The fund industry would like to have you believe that managers cleverly move your money around from one stock to another to avoid losses.

The truth is that every mutual fund must keep a certain percentage of its money in cash or cash equivalents to deal with the constant inflow and outflow of investor money. During the fourth quarter of 2008, the TSX composite dropped about 23%. This means that cash in your mattress outperformed stocks by a wide margin.

So, mutual funds got a return “bump” because they held cash. This bump was more or less offset by the fees charged by the funds leaving us with roughly a tie between the funds and the index. If you had 10% of your money in cash and 90% in the TSX composite index, you would have outperformed the majority of active Canadian equity mutual funds.

Of course, it makes little sense to judge any investing strategy over only three months of returns. Fortunately, the SPIVA scorecard gave results for longer periods. Over the last year, 58.1% of active funds underperformed. For the last 3 years, 79.0% of active funds underperformed, and over 5 years, 88.8% underperformed. These damning figures should make any sane person think twice before investing in actively-managed mutual funds.


  1. Thicken: The practice of buying more of a stock to drive up its price just before quarter end seems wrong to me, but apparently it goes on. This will increase a mutual fund's return for a given quarter, but the stock will slide back on the first day of the next quarter. So, the mutual fund gets some benefit the first time they do this, but in subsequent quarters, the loss at the beginning of the quarter offsets to gain at the end of the quarter.

    1. The comment above was a response to Thicken My Wallet's comment:

      Great post. There is also the obvious point that most managers make end of quarter/year trades to make their performance look better.

      I would love to see a study where they looked at the performance of the fund taking out the last couple of trading days in a quarter.

  2. I've always thought that active managers outperform in bear markets -- after all, they hold a bit of cash and cash is king in bear markets. The SPIVA reports for the last 2 quarters of 2008 show that this isn't always true. As you point out, the record of active managers versus the benchmark is a statistical tie.