Can you match the index plus 50%? - Dream on

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In a strategy meeting we were asked if we thought it was possible to consistently, year in and year out, add 50% in return on top of an index’s return. “Dream on” was the most polite answer in the room. We were looking at why closet indexed portfolios continues to fail.

We were being shown a case a where a closet indexing fund was 95% the same as the index it follows. There are more funds like this than one would care to think.

The presenter took this example and tore it down by the numbers to show why these funds can’t beat their index.

If a fund 100% matches an index, it would underperform the index by what the fund charges. So if the index had a 12.5% return and the MER (management expense ratio) of the fund was 2.5%, the fund would return 10% to the investor.

By the way, the returns a fund posts is the return to the investor; after fees. Lately I have met a few investors who believed that the fees were taken off of the published return.

We are finally seeing the end of Index Mutual Funds

A few years ago self- advised investors were buying index mutual funds, only to find out that they could only underperform. Their reason for buying was usually that a newspaper article told them that lower fees were the only factor they need to look at. They jumped on this badly thought out advice not realizing that these fees, even though they were lower, were the reason they were guaranteed to underperform the index: the very index they were trying to beat.

We don’t see this much in the public realm anymore as investors have seen the flawed logic. Unfortunately, group pension plans are offering more of these index funds than ever, and with no advice offered to the employee, index funds are consistently and mistakenly being chosen as a safe choice.

Can you match the index plus 50%?

The case study showed a fund that is 95% the same as the index and the MER (fees) is 2.5%. That means that 5% was not a copy of the index. In order for the whole fund to make the same as the index, this part of the portfolio has to match the 12.5% that the index returned PLUS another 50%.

That does not mean beating the index by 50% (18.5% total return). This part of the fund would have to earn 62.5% for the whole fund to just match the index return. Closet indexers are everywhere; they skew the mutual fund average return drastically down. All mutual funds start to get a bad reputation by association.

This average is the main reason constantly used by poorly informed writers who state all funds are bad. Truth be known, the writer is simply keeping up their reader numbers to keep being published. Eventually they start to believe what they write is fact. A sad state of affairs for their readers.

No wonder these funds continue to underperform!

You will find many more closet indexing funds that only vary from the index by 10%. This 10% of the portfolio would have to earn the same return as the index (12.5%) PLUS another 25%. In other words, 10% of the fund must have a return of 37.5% for the whole fund to just match their corresponding index.

Unfortunately for the public the number of closet indexers is growing.

You deserve better

This is why good independent advisors (a number that is shrinking) do a lot of work breaking down each and every investment and fund, meeting with the portfolio managers and tearing down their investment philosophy. They then make sure the portfolio managers they like stay true to their investment philosophy.

Tomorrow I am going to Toronto with a group of independent advisors from our office to meet and challenge three portfolio managers from three different families of funds at CI Investments.

CI will also cover the enhancements in their Private Investment Management offering; one of the prime benefits is reduced fees for high net worth investors. We will also tear apart the workings of an innovative guaranteed income investment. Hopefully it is as good as it claims to be.

Advisors Forced to Sell Proprietary Products

No one Mutual Fund Company can have the best of every possible type of fund. Despite this, a growing number of companies in the advice industry are restricting, or controlling advisors through better payouts, to only buy the products the financial institution controls, increasing the corporation’s profit per customer. It is all about the institution’s profit. I equate it to only being able to choose from no name products at the grocery store and still pay the price of choosing your own national brands.

No Due Diligence

Obviously these advisors can not perform the due diligence needed to find the best product for the risk profile of each of their clients. They must choose the right type of fund for their clients with no choice of portfolio managers. The time saved from the lack of proper due diligence allows them more time to sell. Most of these firms’ funds are the kings of closet indexing.

Working together with the professional independent advisors in my office allows us to make sure no rock goes unturned and we thoroughly understand each offering. See my article on our practical think tank.

A great side effect

A side benefit for a full service, all products, advisor from these meetings is we find some great individual investments. We then research the ones that interest us and any that pass our own in depth analysis can be recommended to the appropriate clients at the appropriate time. Each advisor makes their own final decision if that investment gets shelf space to use appropriately.

YOUR INDEPENDENCE MATTERS and if you want to see what a truly independent investment/insurance advisor can do for you, call me at 905-846-9060, ext.3838, email me at or visit my website at