Tired of Closet Indexers?

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Understanding Active Share

There is nothing that drives me nuttier than reading articles from writers who do not understand their topic. We run into this in the investment industry a lot. One area that drives me the nuttiest is the haters of investment funds (mutual, segregated and pooled). Most are simply pushing their agenda. While full service advisors do invest in direct investments (stock, bonds, GICs etc.) there is a place for funds in the investment world and they should be willing to use them.

Most of these writers do not take the time to understand funds, learn about the fund they are writing about, the mandate of the fund or what rules the fund must follow in its prospectus. They simply look at a few carefully selected statistics, do a little simple math and declare all funds or a particular fund as inferior. No proper homework is ever done.

I do have to admit that far too many funds simply mirror the index. They have a variance of maybe 1% or 2% from the sectors that are in the index. In the industry we call these “closet indexers”. To me, the vast majority of these funds are simply charging too much for work that is being done. 

There is a better way

There are funds that don’t worry about the index but simply do their best for their investors. Their portfolios rarely match the index; and when they do it is because they feel that is the proper investments for the times. This is called ACTIVE SHARE.

In 2007 a study was done to prove what good advisors have known all along: funds with a higher active-share value would tend to be more consistent in generating high returns against their benchmark indices, which implies that more actively managed funds have more skilled managers. Active share managers aren’t trying to beat the index, they are trying to produce solid long term positive returns for their investors.  This measurement is an average of all active share managers and as with all things in life, some are better at this than others. Studies have shown that this behaviour does, in fact, help them to consistently beat the indices.

Just the start

Now that you have identified good active share funds, a portfolio must be crafted to take into account your Risk Tolerance, Markets, Market History, Economies, Taxes, proper Asset Allocation; within an asset class as well as the proper balance of asset classes. We need to look at the after tax growth, any guarantees required, potential protection against creditors and if income is required; producing the right after tax income and growth balance for you. Another area that must be taken into consideration is whether we are investing in your registered account, non-registered or possibly your business account. 

Homework

As you can see, proper homework must be done, starting with an in-depth understanding of Active Share (so few understand or are even aware of this). Your advisor must meet with the managers of funds in which they invest personally to make sure what they are promised is what you get. Crafting the right portfolio for each client is tantamount.

If you want to see what a truly independent advisor can do for you, call me at 905-846-9060, ext.3838, email me at Terry.McIntyre@manulifesecurities.ca or visit my website at www.terrymcintyre.ca.