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Why active managers are getting revenge, pot stocks hot again, and an all-new model dividend portfolio

Cannabis seedlings at the Tilray medical marijuana grow-op.

John Lehmann/The Globe and Mail

Bob Farrell was a revered former strategist at Merrill lynch and his Ten Rules of Investing still influence modern day professional investors. One of these rules, "When all the experts agree — something else is going to happen" now applies to the debate active versus passive investing strategies.

In an October 3 research report, Merrill Lynch's current chief quantitative strategist Savita Subramanian recently noted that 54 per cent of active U.S. fund managers were beating their benchmarks so far in 2017, "the highest hit rate at this time of the year in our data history going back to 2009."

How can this be true? Didn't we agree that all active fund managers are flailing, overpaid morons?

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The truth remains that passive, broad index-based investing is the best option for the majority of investors over the long term – all of the credible research shows that. But, it is also important to note that the relative performance of active and passive investing strategies is cyclical, and we might be entering a market environment where active managers have a better chance to beat the index.

The past few years have seen the U.S. market driven in large part by the FANG stocks – Facebook Inc., Amazon.com , Netflix Inc and Google parent company Alphabet Inc. In these circumstances, it is almost impossible for portfolio managers to beat the benchmark.

In markets driven by a small number of companies their stocks inevitably become expensive, as Amazon.com's price to earnings ratio of 244 times underscores. In the interests of managing portfolio risk, very few fund managers are willing to hold marketweight positions in stocks when they are that overvalued. So they hold an underweight (or no) position in Amazon that almost guarantees the fund underperforms the benchmark for as long as the trend lasts.

Portfolio managers typically outperform when market leadership is broad – when a large number of companies contribute roughly equally to index returns. With this market backdrop, a skilled manager can beat the benchmark by buying the most attractively valued (cheapest) of the market leaders.

I would suggest that investors add to holdings in actively managed funds here, but practical concerns preclude it. With thousands of fund options available, it's simply too hard to separate quality portfolio managers from flash in the pans.

But I also wouldn't be surprised if Mr. Farrell's rule applies, and after 'passive is better than active' became the consensus view, portfolio managers enjoy an extended, if temporary, period of proving this wrong.

-- Scott Barlow, Globe and Mail market strategist

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The Rundown

Say hello to John Heinzl's new Yield Hog dividend portfolio

Now that Strategy Lab has ended its five-year run, John Heinzl is unveiling his new Yield Hog dividend growth portfolio. You'll notice some overlap with the stocks in the old Strategy Lab portfolio, but there are also some key differences. The new portfolio is bigger – it has 22 securities, up from 12 – and the starting value has doubled to $100,000. Read all about it here and see the entire portfolio by clicking here.

Why the bull case for global financials doesn't apply to Canada bank stocks

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Wall Street bullishness on global financials has reached fever pitch after attractive valuations and rising interest rates drove the sector to strong performance in September. Scott Barlow applied this thesis to domestic bank stocks and found that, while there's no reason to be bearish, the bullish rationale does not apply.

Pot stocks suddenly hot again
Investors are once again bullish on cannabis stocks as governments unveil measures that move Canada closer to legalizing recreational marijuana. Brenda Bouw explains why.

Canadian hedge fund bets on gaming stocks, shorts autos to beat Canada peers
JC Clark Ltd., which runs a Canadian hedge fund that's outperformed indexes for almost two decades, is now taking a more defensive approach, shorting sectors that it sees in long-term declines, such as grocers, while adding to gaming stocks. Read all about his latest moves here.

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What's up in the days ahead

It was 10 years ago this Monday that markets started their historic fall that culminated with a financial crisis that still shapes markets to this day. In Saturday's Globe Investor, we'll take a look back at the lessons learned and ask, can it happen again?

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Compiled by Darcy Keith

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