Winnipeg Free Press - PRINT EDITION

Tanking markets add fuel to active vs. passive debate

The meltdown of investment portfolios has intensified the debate between active versus passive money management.

Active management involves an individual or money manager buying and selling stocks as market and corporate conditions change, while passive management means buying all stocks in a particular index, such as the S&P/TSX Composite.

The theory has been that passive management often outperforms when stock markets are going up, as a rising tide lifts all boats, but active management tends to fare better as markets fall, since managers can get rid of poor-performing stocks that indexes must still hold.

Markets in Canada and the U.S. reached multi-year lows last November, and conflicting reports have been issued about whether active or passive management fared better.

TD Waterhouse said in a recent release that it "has seen an increase in new account openings, higher volumes of trades and greater frequency of trading," because "market volatility means (investors) want to take greater control of their investments."

Meanwhile, a huge battle is going on between the mutual-fund industry and exchange-traded funds.

Mutual funds, with annual fees or management expense ratios averaging 0.5 per cent for bond funds and 2.5 per cent for Canadian equity funds, have been dumped on for charging such fees while funds have been delivering deeply negative results.

Trying to take advantage of that disgruntlement are exchange-traded funds, which are essentially index funds that trade like stocks, with buying and selling commissions and real-time prices. Most ETFs are passively managed, holding stocks according to a particular index, and thus have minute management fees.

In an interesting twist, the Business News Network has aligned itself with the ETF industry, although only one-twelfth as many Canadians own ETFs compared to mutual funds. BNN scrapped a frequent mutual-fund show and now runs a daily ETF report and weekly ETF show. Advertising by ETF companies on the channel dwarfs that of mutual fund firms.

Just how well index funds and ETFs did compared to equity mutual funds during the fourth-quarter of 2008 varies, depending on the fund universe being measured, the index tracked and whether fees were included.

Russell Investments Canada Ltd. reported that when you exclude fees for both active management and the S&P/TSX Composite index, active managers beat the benchmark 72 per cent of the time during the last three months of 2008. That was highest since the second quarter of 2004, as managers returned an average of 1.4 per cent better than the index. A major reason was a general overweighting by managers of Barrick Gold Corp. and Goldcorp Inc. during the bear market.

During all of 2008, some 68 per cent of active managers beat the benchmark, by an average of 1.2 per cent.

However, Standard & Poor's, among the world's largest index providers, reported in its regular Standard & Poor's Index Versus Active funds report, that only 53.2 per cent of Canadian active-fund managers outperformed the S&P/TSX during the last quarter of 2008 after fees and expenses.

Three main companies offer ETFs in Canada -- Barclays Canada, Claymore Investments and Horizon BetaPro -- and they are innovating and bending the usual ETF world.

Some ETFs offer trailer fees to financial advisers who will recommend the funds to clients. And unlike the mutual-fund industry, BetaPro offers some ETFs that return once or twice the amount a particular index goes up, while also offering others that return once or twice the amount an index goes down. In fact, BetaPro reported that two-thirds of its funds sold late last year were Bear Plus funds hoping for stock markets to tank.

Thus ETFs have extrapolated buying individual stocks long and selling them short, profiting when they go up or down in value respectively, into having the same options for entire indexes.

It's like when racetracks used to offer a quinella for picking the top two finishing horses. Then it came up with the exactor that made you pick the correct order of the top-two finishers, essentially costing bettors twice as much if they wanted to hedge their bets.

While the debate continues over the strategy of hedging your bets using ETFs, more advisers suggest using a combination of mutual funds for the long haul and ETFs for getting in and out. The latter works best when markets are going up and down in the short term, but not moving in the long run.

One ETF company even advertises the evolution of the industry as having gone from mutual funds to index funds to ETFs to the newest wrinkle, actively-managed ETFs. The picture is blurring.

-- Canwest News Service

Republished from the Winnipeg Free Press print edition April 19, 2009 C7

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