If you enjoy researching companies and beating the market, there’s nothing wrong with that. My job is to simply point out what the data shows has worked best for the average investor over time.
For many Canadians, investing is a means to an end, not a hobby. If that sounds like you, outsourcing the work to a low-cost, passively managed index ETF could make a lot of sense. The evidence supporting this approach is hard to ignore.
One of the most cited sources is the S&P Indices Versus Active (SPIVA) study, which compares actively managed funds to their benchmark indices. When you look at the performance of Canadian stock funds, the conclusion is clear: most active managers can’t keep up.
How to interpret SPIVA
On the S&P Global website, the SPIVA scorecard provides an overview of how actively managed Canadian equity funds perform against their benchmark over different time horizons. These include tracking periods of 1, 3, 5 and 10 years, with the benchmark being the S&P/TSX composite index.
The results are not flattering to active management. Over a one-year period, approximately 94.7% of Canadian stock funds underperformed the index. In three years that figure will rise to 93.7%. Over a five-year period, 84.5% lagged behind the benchmark. Over a ten-year period, 97.6% failed to keep up.
A major reason for this underperformance is compensation. Many actively managed Canadian mutual funds, especially those sold through bank branches, charge high management expense ratios (MERs). These costs are deducted every year.
Just as dividends can be positive over time, high fees can be negative. Even if a manager makes good investment decisions, the cost loss alone can be enough to reduce long-term returns.
This does not mean that no active fund will ever outperform. Some clearly do. The problem is identifying those winners in advance and retaining them for longer periods of time. For most people, this means active fund selection is a lost cause.
The practical takeaway
If you accept the statistics, the logical conclusion is to use a passive index ETF. My preferred option for broad exposure to Canadian equities is the iShares Core S&P/TSX Capped Composite Index ETF (TSX:XIC).
This fund tracks a benchmark that is very similar to the benchmark used in the SPIVA study. The “capped” feature limits each individual share to a maximum weight of 10%. This is important because it reduces concentration risk. In the past, companies like Nortel grew so big that they dominated the index, causing problems when something went wrong.
This ETF essentially buys most of the Canadian stock market in a single fund. You get exposure to 213 large, medium and small companies, weighted by market capitalization. As you would expect given the structure of the Canadian economy, the largest sector holdings are financials at 33.2%, materials at 17.6%, energy at 14.5% and industrials at 10.6%.
Cost is one of the biggest advantages here. The ETF calculates an MER of only 0.06%. For a $10,000 investment, that equates to about $6 per year in costs. It can be purchased commission-free from many brokers and currently pays a 12-month dividend yield of around 2.2%, most of which comes from eligible Canadian dividends.
For investors looking to own Canadian stocks in an easy and cheap way, I think XIC is as close to a set-it-and-forget-it option as you can get.
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