Beat 97.7% of Actively Managed Funds in Canada With This 1 Cheap Index ETF

Contrary to what some people think, I’m not against stock picking. While most readers know I’m an exchange-traded fund (ETF) guy, I’ve always taken a laissez-faire approach to investing. After all, it’s your money.

If you enjoy researching companies and trying to beat the market, there’s nothing wrong with that. My job is simply to 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 can make a lot of sense. The evidence supporting this approach is hard to ignore.

One of the most widely cited sources is the S&P Indices Versus Active (SPIVA) study, which compares actively managed funds with their benchmark indexes. When you look at the results for Canadian equity funds, the takeaway is clear: most active managers fail to keep up.

How to interpret SPIVA

On the S&P Global website, the SPIVA scorecard breaks down how actively managed Canadian equity funds perform relative to their benchmark over different time horizons. These include 1-, 3-, 5-, and 10-year trailing periods, with the benchmark being the S&P/TSX Composite Index.

The results are not flattering for active management. Over a 1-year period, about 94.7% of Canadian equity funds underperformed the index. Over 3 years, that figure rises to 93.7%. Over 5 years, 84.5% lagged the benchmark. Over 10 years, 97.6% failed to keep up.

A major reason for this underperformance is fees. Many actively managed Canadian mutual funds, especially those sold through bank branches, charge high management expense ratios (MERs). These fees are deducted every single year.

Just as dividends can compound positively over time, high fees compound negatively. Even if a manager makes good investment decisions, the fee drag alone can be enough to sink long-term returns.

This doesn’t mean no active fund ever outperforms. Some clearly do. The problem is identifying those winners in advance and sticking with them over long periods. For most people, that makes active fund selection a losing game.

The practical takeaway

If you accept the statistics, the logical conclusion is to use a passive index ETF. My preferred option for broad Canadian equity exposure is the iShares Core S&P/TSX Capped Composite Index ETF (TSX:XIC).

This fund tracks a benchmark very similar to the one used in the SPIVA study. The “capped” feature limits any single stock to a maximum weight of 10%. This matters because it reduces concentration risk. In the past, companies like Nortel grew so large that they dominated the index, which created problems when things went wrong.

This ETF effectively buys most of the Canadian stock market in a single fund. You get exposure to 213 large-, mid-, and small-cap companies, weighted by market capitalization. As you’d expect given the structure of Canada’s economy, the largest sector exposures 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 charges a MER of just 0.06%. On a $10,000 investment, that’s roughly $6 per year in fee drag. It can be bought commission-free at many brokerages and currently pays a trailing 12-month dividend yield of about 2.2%, most of which comes from eligible Canadian dividends.

For investors who want a simple, low-effort way to own Canadian equities, I think XIC is about as close to a set-it-and-forget-it option as it can get.

The post Beat 97.7% of Actively Managed Funds in Canada With This 1 Cheap Index ETF appeared first on The Motley Fool Canada.

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More reading

• Here’s the Average TFSA Balance at Age 54 in Canada
• 3 Canadian ETFs to Buy and Hold Forever in Your TFSA
• Want a $1 Million Retirement? 2 Simple Index Funds to Buy and Hold for Decades

Fool contributor Tony Dong has no position in any of the stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.