In last weekend’s Financial Post, Jonathan Chevreau wrote an admiring piece about Dynamic Funds, one of the oldest fund families in Canada. The article profiled seven funds with 10-year track records of outperformance that “leave index-hugging rivals behind.”
“Many financial columnists, including yours truly, have imbibed the Kool-Aid of passive indexing and exchange-traded funds (ETFs),” Chevreau writes. “Many popular books refute the idea actively managed mutual funds can beat the indexes and recoup their fees.” He then goes on to say he was “shocked” that these seven funds managed to do just that, even though two of them have MERs over 4%.
First of all, acknowledging the power of index investing is not “imbibing the Kool-Aid,” which implies blind acceptance of an unproven claim. The futility of active management as a whole is not an opinion, it’s simple math. As this classic paper by Nobel laureate William Sharpe explained 20 years ago, “Properly measured, the average actively managed dollar must underperform the average passively managed dollar, net of costs. Empirical analyses that appear to refute this principle are guilty of improper measurement.”
They key phrase here is “average actively managed dollar.” No sensible person would ever “refute the idea actively managed mutual funds can beat the indexes,” as Chevreau argues. Of course mutual funds can beat the indexes. Every year many of them do, and some have outperformed for 10 years or more, including the Dynamic funds profiled in the FP article. There is nothing shocking about this. The question is, how can an investor identify in advance which ones will outperform? Unless we can do that, past performance is as useful as last week’s football scores.
Chevreau suggests that Dynamic’s excellent track record is a useful basis for investors who are looking to beat the market going forward. I don’t think it is. I’m not disparaging Dynamic’s managers, and I’m not prepared to write them off as dart-throwers who simply got lucky. These managers are undoubtedly skilled and they made some great calls. However, 10 years ago, investors could not possibly have known that these funds would have been winners. Here’s why:
- Have a look at the list of funds available from Dynamic. It’s enormous — even excluding the US-dollar versions and the hedge funds, I counted close to 100. Why should we be surprised to see seven funds with excellent track records in a family this large? Perhaps Dynamic would be willing to publish the 10-year performance of all of their funds so investors can see what percentage of them outperformed.
- Of the seven funds named in the article, only two have the same managers today (Chuk Wong and Noah Blackstein) that they did 10 years ago. If you chose any of these funds a decade ago because you admired the manager, you should logically have sold it when the manager departed. By the same token, if you choose a fund today based on the track record of its current manager, you have no assurance he or she will still be managing the fund in five or 10 years.
- In some cases, if you look at these funds’ performance over a different period, they stop looking so good. The Dynamic American Value Fund beat its benchmark over the last 10 years, but not over the last 20, according to Globefund, so how would it have looked to an investor in 2000? The Dynamic Dividend Fund has also lagged over 15- and 20-year periods, and over the last five years, too. How does an investor know what the next 10 years will bring when outperformance comes and goes?
- Survivorship bias makes every fund family’s performance look better than it really is. Chevreau dismisses this by saying “but all Dynamic’s winners have at least 10-year records.” That’s completely missing the point. Of course the survivors have 10-year track records—that’s what makes them survivors. What investors need to know is how many other Dynamic funds have been folded or merged because they have not performed well. And how many have changed their mandate over the last 10 years because the original strategy wasn’t working out?
- It’s questionable whether these funds are even being compared to appropriate benchmarks. Many Dynamic funds have such vague mandates that it’s impossible to measure them against any index. Both the Dynamic Value Fund of Canada and the Dynamic Dividend Fund, for example, are measured against the S&P/TSX Composite, but both have about 30% of their holdings in foreign stocks.
I’m happy to join Chevreau in tipping my hat to the Dynamic managers who performed so well over the last 10 years. But until someone is able identify who we’ll be doffing our caps to in 2020, active management remains a shell game that most investors will lose.