Thomas Edison was dubbed a wizard when he created the electric light bulb. The Wright Brothers became American icons when they flew the first airplane. But when John Bogle created the first index fund in 1975, it was labelled Bogle's folly. That a passive collection of stocks could outperform most professional money managers was considered a joke. Now, nobody's laughing. Vanguard's Total U.S. Stock Market Index, thanks largely to its popular, lean-cost structure, is now the largest fund on the planet.
Because most money in stocks is actively managed, the average professional trader earns the return of that given market, before fees. After adding management costs, the majority underperform their benchmark index.
But you can't buy a benchmark index – not exactly. You can purchase index funds and exchange-traded funds. But they also charge fees. Do they beat actively managed funds after doing so? Taking indexing theory to the street, let's see how some of Canada's fund providers compare with indexes you could actually buy.
Enter our first contender in this comparative series: RBC's family of mutual funds. I'll focus on funds from four broad categories: Canadian fixed income, Canadian equity, U.S. equity and international equity. I'll eliminate funds without 10-year track records, as well as specialized and sector funds.
On the indexing side, I'll use iShares' ETFs and TD's e-Series funds. Lower-cost ETFs exist. And with indexing, the lower the costs, the better the performance. But as pioneers in the Canadian industry, indexes from these two firms have recorded 10-year track records for each of the four main asset categories.
In a boxing match, adversaries face off in equal weight divisions. In the same vein, competing investments should represent the same geographic and asset class sectors. There's no point tossing a Canadian dividend-focused ETF, for example, against a small cap-focused mutual fund. Sometimes dividend stocks outperform small caps; other times it's the other way round. In an active versus passive fund fight, we need apple-to-apple comparisons.
Canadian Non-Specialized Fixed Income
RBC lists five actively managed fixed-income funds with 10-year track records. Only one of the stalwarts, the RBC Bond Fund, focuses on non-specialized, high-quality corporate and Canadian government fixed income. Using the DEX Universe Bond Index as its benchmark, the fund's expense ratio is 1.22 per cent. RBC reports an average decade return of 4.3 per cent.
Two lower-cost indexed challengers of the same class are iShares XBB-DEX Universe Bond Index (XBB) and TD's e-Series Canadian Bond Index. Costing 0.33 per cent and 0.5 per cent respectively, they've each out-jabbed RBC's Bond Fund. The iShares ETF averaged 4.87 per cent for the decade; TD's index earned 4.57 per cent.
RBC lists two non-specialized actively managed Canadian funds with 10-year track records.
Their Canadian Equity Fund costs 2.07 per cent a year, and it averaged 6.5 per cent. The O'Shaughnessy Canadian Equity costs 1.55 per cent and averaged 7.8 per cent.
Like boxers carrying too much weight around the middle, they were outpointed by the iShares S&P/TSX Capped Composite Index (XIC), up 7.89 per cent a year, and TD's e-Series Canadian Equity Index, which averaged 7.63 per cent.
RBC's actively managed U.S. Equity Fund also slipped on the canvas. It gained 2.7 per cent for the decade, after charging 2.11 per cent per year.
Taking advantage of its lower cost footing, the iShares S&P 500 Index (XSP) earned 4.86 per cent, while TD's e-Series U.S. Index averaged 4.54 per cent.
The bank produced an equally punch-weary performance in the international equity category. RBC's actively managed International Equity Fund averaged 2.3 per cent for the decade, after costs of 2.27 per cent.
The much cheaper iShares MSCI EAFE Index (XIN) averaged 3.29 per cent, after costs of half a per cent. TD's e-Series International Index earned 4.53 per cent after costing 0.51 per cent.
Based on the four asset class categories, RBC's actively managed team underperformed the indexed products by 1.16 per cent per year. On a $10,000 investment equally allocated across each fund category, the indexes would have beaten the actively managed products by $1,222, or 12.2 per cent overall.
Did Canada's other large fund companies do any better? In this occasional series, we will find out.
Globe app users click here for table