The active vs. passive debate:
who wins?
By Fundata Analytics

Toward the end of 2016, the active vs. passive portfolio management style debate raged. Those arguing in favour of active management predicted that actively-managed funds would outperform the broader market universe in 2017, including index funds. How did that turn out? The results might be an eye-opener to some.

History has shown that surpassing benchmark performance – or even beating the market rate of return – is becoming increasingly difficult.

As world economies become more interconnected, capital markets continue to move towards the strong market hypothesis theorem. Looking back at 2017, we see that several events occurred in global financial and political markets fueled one of the strongest bull runs in market history.

Among the most important events was the election of Donald Trump as 45th President of the United States. Capital markets took a particular liking to this, as the “priced-in” result of the election had Hillary Clinton as the favourite. At the time, healthcare sector stocks and broad equities alike were pummeled. But markets revived on Trump’s relatively laid back stance on corporate tax cuts and a promise to spend a massive $1 trillion on infrastructure, having a halo effect in Canada and other regions of the world.

Canada had quite the year in terms of economic developments during 2017. With inflation at near all-time highs during 2016 and early 2017, Bank of Canada Governor Stephen Poloz finally began to unwind the decade-long stimulation of low interest rates that followed the financial crisis of 2008. The timing of the rate hikes was critical, as Canadian house price indexes had soared along with the flow of easy money to higher credit-risk individuals.

After a couple of rate hikes, the Canadian target overnight bank rate now sits at 1.25%, which along with other measures like special forms of local taxation on foreign buyers and mortgage stress tests, has helped bring sky-high real estate valuations back to earth, taking some of the steam out of real-estate-bubble alarmism.

The year also proved to be an important one for many other countries. A particular catalyst to Asian capital markets came with the appointment of China’s Premier Xi Jinping to a second (and probably perpetual) five-year term in office. Other noteworthy events included the accession of a new “modern-capitalist” heir to Saudi Arabia’s throne, Mohammad bin Salman, whose views closely align with those of President Trump. Bin Salman has also proposed taking state-owned Saudi Aramco public, a move that would trigger some portfolio rebalancing for our energy sector professionals indeed.

Meanwhile, British Prime Minister Theresa May continues to negotiate towards a soft exit (Brexit) from the European Union (EU) by triggering Article 50 of the EU agreement and extending negotiations to March 29, 2019. As a result, geopolitical uncertainty remains, while volatility has ramped up in U.K. and European markets.

Using Fundata’s proprietary database and investment fund information, we extrapolated the return of different investment vehicles on an aggregated basis, mimicking the larger Canadian, U.S. and global equity markets.

The graph shows the mean and median returns for Canadian Equity, U.S. Equity, and Global Equity vehicles using a universe of approximately 1,000 mutual funds and ETFs.

In some types of equity funds, index-based funds outperformed actively-managed funds in 2017. In other cases, it was a wash or nearly so. It is noteworthy that investment funds with global mandates outperformed their indexing peers in both the mutual fund and ETF categories. To understand why this occurred in this category specifically, we analyzed holdings data and concluded that the bulk of these global mandate funds held U.S.-based securities; hence, they benefitted from the optimistic sentiment driving capital markets south of the border during 2017.

During a recent conference call, portfolio manager Jeremy Yeung of CI Investments, who co-manages the CI Signature Global Science & Technology Fund, weighed in on the performance of equity markets during 2017: “The Canadian market is highly concentrated. If you look at the top-10 names in Canada, they hover around oil and financials,” he said. “The United States is a very tech-centric market, with nearly a 20% makeup for S&P coming from information technology. If you were not overweight technology in 2017, you would have an underperforming fund,” he added.

“The technology sector was the underlying driver to the U.S. market boom in 2017, and the majority of managers do not understand the business model or valuation,” said Yeung, adding, “Digital disruption continues to be the driver of capital market expansion in the United States and China. We continue to welcome the fundamental shift from offline to online in the coming years.”

So does passive management (indexing) prevail as a choice of style? Not necessarily. As always, it depends on your personal investment goals. Some active mutual funds and ETFs posted stellar results, including Yeung’s Signature Global Science and Technology Fund, with a calendar return of 33.46% in 2017.

It is always important to perform all your due diligence when selecting an investment fund, taking into account the competency of the managers, their access to company management, and overall investment style. Whether you are an indexer or active investor, doing macro-level research can translate to a fairly large difference in your ultimate investment return.

© 2018 by Fund Library.

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