An Interview with John De Goey

January 4, 2013

On Monday, the UK implemented new rules banning embedded commissions on investment products. We’re still many years away from that in Canada, but it’s not for lack of effort on the part of John De Goey. For a decade now, the associate portfolio manager at Burgeonvest Bick Securities in Toronto has been a thorn in the side of the industry. Like almost all his contemporaries, De Goey started out selling mutual funds with deferred sales charges, but later become one of the early adopters of the fee-based, no-commission business model.

I chatted with John about his recently published book, The Professional Advisor III: Putting Transparency and Integrity First, a passionate plea for changes to the advice industry. Here’s an excerpt from our interview.

DeGoeyThe first two editions of your book were published back in 2003 and 2006. A lot has changed in the investment industry since then.

JDG: When I wrote the first two editions, I knew more people in the advisor media—Advisor’s Edge, Advisor’s Edge Report, Investment Executive—and they were the ones writing about the book. So all I managed to do was piss off other advisors, and consumers didn’t hear the message. Now I am getting more interest from the Globe, the Financial Post, and people like you and Preet Banerjee, who are reaching ordinary investors. And the good news is, today they get it.

When I started in the business in 1993 the media were talking about the importance of cost, but in those days it was more like, “You can save money by investing with a company like Mawer or Beutel Goodman.” It was about low-cost actively managed funds that didn’t pay trailing commissions. When ETFs came along a little over a decade ago, they changed the game: advisors like me loved them because they allowed me to build portfolios using building blocks that were cheap, pure, broadly diversified and tax-effective. But when I first started talking about unbundling products and charging an asset-based fee in 2003, it was heretical. Today it’s mainstream.

I enjoyed the section where you talk about the deficiencies in the way advisors are educated. When I took the Canadian Securities Course, I too was amazed to find indexing gets only a few paragraphs. Is it any wonder so few advisors advocate passive strategies? Do they even know about the evidence?

JDG: The reason there’s so little discussion about passive strategies is that the industry has grown up with a culture of sales. The presumption, which is pretty much unsubstantiated, is that you can beat the market and therefore you should try to beat the market by using active products and strategies. As soon as you start from that premise, you’re going presumptively down one path, which is what I say about the Canadian Securities Institute textbooks. They teach people that active management is sensible management. But that’s putting the cart before the horse. You should stop and ask what the options are and what works—not only on an absolute basis, but on a balance of probabilities. Because neither option is unequivocally, 100% better all the time.

A lot of firms and advisors are advocating core and explore—even ETF providers themselves. Do you think adding an actively managed satellite component can ever add value?

JDG: I’m personally doubtful. Can it ever add value? I suppose there may be one or two instances. Can you ever win the lottery? Yes you can, but does that mean I’m going to run out and buy a ticket today? Just because it’s possible doesn’t mean it’s probable. And the next logical step is to conclude that because it’s not probable, it’s not advisable. For some people it might work, but I still believe whenever one pursues an active strategy, whether it is for 100% of their money or for a 10%, 20% or 30% satellite portion of their portfolio, the most likely reason for any outperformance is likely to be luck rather than skill.

You mention in the book that one of the reasons you gave up your column on Advisor.ca was you couldn’t get your compliance department to let you compare active management to gambling. What happened there?

JDG: Daniel Kahneman in his book Thinking Fast and Slow uses that exact same metaphor. Well, if it’s an unfair comparison, it ought to be unfair no matter who is making it. Yet a Nobel laureate can make it, because he doesn’t have a license, but an ordinary guy like me can’t make the comparison because I have a license and I’m regulated. It isn’t just my firm. At any firm they’re scared of regulators saying it’s detrimental to the public interest, and it’s portraying the industry in a negative light. I don’t think that’s the case: I think it is a full-truth, plain disclosure of material considerations.

The example I use is the packaging on cigarettes. That is now prescribed by law because the evidence is very clear there’s a linkage between cigarette smoke and cancer. Just because there might be exceptions—people who smoke all their lives and don’t get cancer, and people who never smoked and do get cancer—that doesn’t prove the linkage does not exist. It’s just a balance of probabilities. I’m not going to say you can’t frequent the casino or buy a lottery ticket. I’m just saying you need to understand the odds are against you. The same logic holds when pursuing active strategies: you might do better, but the odds are you will do worse.

{ 74 comments… read them below or add one }

Oldie January 7, 2013 at 5:08 pm

@CCP: the second article that Dan Hallett, above, directs us to mentions us to a so-called “Easy-Chair Portfolio” designed by Eric Kirzner 15 years ago. While I only have Dan H’s description to go by, it appears to be essentially the equivalent of a Canadian Couch Potato portfolio, which suggests that wisdom is not exclusively held by us :).

The only anomaly is the described 20% allocation to cash. Now, I am not privy to what the strategy was. But if it was invested in an interest bearing vehicle and periodically rebalanced to 20%, then it would exactly match how a Couch Potato Portfolio is supposed to be set up. But if it was not invested, and kept in cash for a not-specified occasion, perhaps a newly arising buying opportunity that occurs in the future in the face of, perhaps, (also not specified) a strategy of continuously monitoring market conditions, then this would be a tactical decision, thus disqualifying the portfolio from being designated as Couch Potato style. Am I correct on this @CCP?

Noel January 7, 2013 at 5:24 pm

@Dan Hallett – Thanks for posting those articles. I don’t disagree with anything you have said in them. However the latter article only proves my point. I keyed your portfolio into Globefund for the dates you specified and calculated the returns using the asset allocations you used. I calculated a slightly higher return than you show for your portfolio in the article and I can only attribute that to fees that you may have charged and perhaps some rebalancing you might have done. But, using the higher returns I calculated for your portfolio and comparing this against a portfolio using the index benchmarks (not index ETFs) provided by Globefund for each of these holdings, the latter returned a full 80 basis points more on average per annum. Assuming a small tracking error and performance drag attributable to the Index ETF MER the latter portfolio likely showed at least the same or better performance. Of the four holdings in the latter, only the MSCI World index showed more volatility than the comparable Trimark Fund-SC holding and given it was only 15% of the total portfolio it would not have contributed much more to the entire volatility.

Similar volatility and equal or better performance using Index ETF’s? Sounds like actively managed mutual funds don’t add value, at least in reference to the example you posted in that article. However, I do agree that active management insofar as it encompasses the creation of an Investment Policy Statement and adherence to it does add value. And, this is what it is worth paying investment advisors to do for clients that have no desire to educate themselves to be DIY passive index investors or furthermore the discipline to execute such a strategy on a consistent basis. But, there is no proof that using actively managed funds in portfolio construction provides superior or equal performance over time over passive index funds. Quite the contrary, as the latter overwhelmingly shows a higher probability of superior performance.

Oldie January 7, 2013 at 5:43 pm

@Jas: At the risk of appearing to think my meagre knowledge as a neophyte is worth more than it actually is, I think I have a reasonable offsetting argument to your statement:

My understanding is that most academic experts in modern economic theory agree that the universe of small cap stocks, whether in the Canadian, US or World markets have a higher return over the long term than the total market, which is dominated by the higher cap stocks. The penalty you pay with small cap investing is higher volatility, i.e. risk, but if you stay in the market long enough to ride out the risks, then you reap the corresponding profit. So any portfolio component that includes this low cap component will participate in the expectation of higher long-term returns, but also in the expectation of higher risk. This would provide the only explanation we need for the “outperformance” of Mawer compared to a total market index. A comparison against the small cap index would have been more pertinent. In other words, I would have argued that a Passively Managed portfolio invested with significant weighting to small cap index funds would have done as well, or even better, considering that we would not have had to deduct the 1-2% (or whatever it was) additional management fee for the Active Management component. Indeed, among the several alternative model portfolios listed in this blog (see the links at the top of the page) is the Uber Tuber Portfolio which has a significant small cap component. However I acknowledge your point that, especially in Canada, investing in small caps is less than ideal due to the higher MER in Canadian small caps ETF’s, and the fact that with our resource and financials dominated economy, the Canadian small cap stocks suffer from a lack of diversification, increasing the risk more than that due to the fact of small capitalization per se.

Now, if you are arguing that the superior returns were not only due to the small cap weighting but also due to the active management of the fund, then that is an additional debate which I believe has been adequately dealt with elsewhere and which I will not reiterate here.

Dan Hallett January 7, 2013 at 6:20 pm

Noel, you may not like the outcome because it completely contradicts the notion that nobody can spot outperformers in advance but the fact remains that even through December that portfolio that I highlighted in that article continues to show outperformance over the original Easy Chair ETF portfolio and the broader indexes. I just updated the data and did the calculations. Raw outperformance with less risk and less volatility – net of fees compared to an index with zero trading costs or MERs.

You don’t have to like it but the numbers don’t lie.

Noel January 7, 2013 at 7:09 pm

@Dan Hallett – I don’t dislike whatever numbers show and I have never said that an actively managed portfolio cannot outperform a passively managed one, just that it is highly unlikely, ie possible, not probable and less so over the longer-term. As for whether the outperformers were spotted or it was just a lucky guess, there is no way of proving that unless one is consistently able to do that. One outperforming portfolio does not show skill any more than one mutual fund outperforming an index over the long-term does. (Does Bill Miller ring a bell?)

What annual % management fees have you factored for yourself in this portfolio, given the client would have had to pay you? Also, portfolio turnover affects returns on actively managed funds much more than a passive index and you haven’t factored that in as far as I can see.

Dan Hallett January 7, 2013 at 7:25 pm

Noel, people simply needed to spend the ~$20 to buy the book The Portfolio Doctor back in 2003 to see my recommendation. Any reader had full access to those funds through many discount brokers at no fee to purchase (excl TDW). And for less than 1% annually, they’d have a good and simple actively managed portfolio.

Noel January 7, 2013 at 7:38 pm

Well I can’t argue with your numbers since you won’t post them, but even at 0.50% annual fee plus the drag of tax on the portfolio turnover the numbers work out less than the index.

But, I wanted to add that if the majority of actively managed funds underperform their corresponding index (and index fund) on an individual basis over the long-term, as is clearly proven by the numbers (ie just over 8% in Canada outdid the index over 20 years) then it only goes to follow that the majority of portfolios constructed of these actively managed funds will similarly underperform a portfolio of the corresponding benchmark index funds over the long-term. You may have managed to pick a portfolio that has overperformed, due to sheer luck or skill, but past performance is never an indication of future performance and the odds are certainly stacked against you.

Jas January 7, 2013 at 7:51 pm

@Oldie:
“comparison against the small cap index would have been more pertinent.”
That is my point, there is no option in canada if a DIY investor wants a balanced passive index funds with small cap tilt with a reasonable MER. If there was, I would prefer it over Mawer’s fund, but it’s a choice we don’t have in Canada (unless you want to work with a DFA advisor). The only Balanced index funds in Canada have high MER, over 1%. At that price, I would rather buy Mawer’s mutual fund which as a small cap tilt and has a solid 20 years track record.

Canadian Couch Potato January 7, 2013 at 7:58 pm

@Oldie and Noel: So far I’ve stayed out of this discussion, but I’ll weigh in with a few points. Oldie, to answer your question about the Easy Chair Portfolio, Prof. Kirzner was writing about passive investing even before MoneySense launched in 1999. The cash component is strategic, not tactical. More here:
http://www.moneyville.ca/article/1231372–15-years-on-passive-portfolio-still-paying-off

I would never consider asking readers of this blog to label themselves in any way. Everyone is welcome here, and everyone can share as much or as little of their personal opinions as they would like.

The passive v. active debate is important, of course, but too often it strays into ideology. I have probably gone down that road in the past, too, though I’ve made an effort not to. I am obviously a committed index investor, but I’ll point readers to this piece for the more nuanced argument:
http://canadiancouchpotato.com/2011/06/27/cant-we-all-just-get-along/

I’m grateful that this blog has attracted a lot of smart, supportive investors (and advisors) whose comments add a lot to its value. It would be a shame if it became a forum for unproductive argument.

Noel January 7, 2013 at 8:15 pm

@Jas – You can definitely achieve a small cap tilt with a reasonable MER by using XIU (or HXT) combined with XMD as CCP discusses here:

http://canadiancouchpotato.com/2012/03/22/under-the-hood-ishares-sptsx-completion-xmd/

@CCP – Thanks for jumping in.

Dan Hallett January 7, 2013 at 8:36 pm

Noel, every time I answer a question you raise a new objection or create one. This is what I was trying to avoid. In September I provided a detailed performance report in my blog post. Now you require an update because you seemingly distrust my figures. And now you’re deducting a fee that doesn’t apply to again try to disprove the evidence provided.

Portfolios used for clients matching that asset mix have approx the same fee as the easy chair or lower so no need to add more fees that don’t exist. And as noted, that particular easy chair mutual fund portfolio was available to anybody who bought the book in 2003 or who opened the right page without even dishing out the $20.

Jas January 7, 2013 at 8:45 pm

@Noel:
“You can definitely achieve a small cap tilt with a reasonable MER by using XIU (or HXT) combined with XMD as CCP discusses here:”

I agree, or by using the “Über–Tuber’ in the model portfolios page, but I wouldn’t say this is an easy solution. You will then need to buy US-listed ETFs for International/US equities and manage a portfolio of 6-9 ETFs. You will have to deal with many potential problems with US-listed ETFs:

- US exchange rate
http://canadiancouchpotato.com/2012/12/17/how-much-are-you-paying-for-us-dollars/
http://canadiancouchpotato.com/2010/01/24/should-you-buy-us-listed-etfs/

- US estate tax
http://canadiancouchpotato.com/2011/12/08/ask-the-spud-am-i-vulnerable-to-us-estate-taxes/

- Double withholding taxes for international equities
http://canadiancouchpotato.com/2012/09/17/foreign-withholding-tax-explained/
http://canadiancouchpotato.com/wp-content/uploads/2012/09/DFA-Foreign-Withholding-Taxes.pdf

Oldie January 8, 2013 at 1:24 am

@CCP: I just revisited your excellent old post as directed

http://canadiancouchpotato.com/2011/06/27/cant-we-all-just-get-along/

A very compelling argument for not going nuts about ideological purity. As always, your moderation and common sense have matched your diplomacy.

Jas January 8, 2013 at 7:26 am

@Oldie:

Dimensional fund advisors balanced index fund with value/small cap tilt (40% bonds) series F 0.65 MER (not available to DIY investors)
http://www.theglobeandmail.com/globe-investor/funds-and-etfs/funds/summary/?compareBench=3155&FromMonth=9&FromYear=2011&ToMonth=1&ToYear=2013&id=86388&symbol=DFA604&style=globe_bal&profile_type=ROB

Mawer balanced index funds (40% bonds)
http://www.theglobeandmail.com/globe-investor/funds-and-etfs/funds/summary/?compareBench=3155&FromMonth=9&FromYear=2011&ToMonth=1&ToYear=2013&id=17966&symbol=MAW104&style=globe_bal&profile_type=ROB

As you can see, the performance of both funds were quite similar during the last year. Both funds have approximately the same asset allocation, including small caps.

Jas January 8, 2013 at 7:31 am

Oops, my mistake. The first link was for Dimensional Fund advisors Series A fund (with 1.75 MER including commission to the advisor), not the series F fund.

Here is the link to DFA balanced funds series F funds:
http://www.theglobeandmail.com/globe-investor/funds-and-etfs/funds/summary/?compareBench=3155&FromMonth=9&FromYear=2011&ToMonth=1&ToYear=2013&id=86389&symbol=DFA605&style=globe_bal&profile_type=ROB

Jas January 8, 2013 at 7:40 am

I wish we could edit our post on this blog :-/
I wrote “Mawer balanced index funds” but I should have written “Mawer balanced fund”.

Anyways, the point was that this low fee actively managed balanced fund seems to capture the same small cap premium than the DFA fund.

Oldie January 8, 2013 at 12:33 pm

@Jas: It appears you have found what you were looking for. In comparing it to Mawer which your analysis says is similar, the purist in me would argue why pay more (MER 0.95 vs 0.65) for active management which statistics suggest adds nothing positive, and likely provides drag in the long run; but after undergoing gentle chiding (“can’t-we-all-get-along”, above :) ) the older, wiser me realizes, hey, the balance is right, maybe the tweaks are minimal, why sweat the small stuff, consider it essentially similar.

@Jas January 8, 2013 at 4:36 pm

@Oldie:
Unfortunately DFA index funds are not available to DIY investors, you need to go through an advisor and use there serie A funds (with 1% commission) or serie F funds with lower MER but only with fee-based accounts which cost usually around 1% of commission.

But yes, if it was available to DIY investors, I would consider this fund a better alternative to Mawer’s. The only balanced index funds in canada are those offered by TD and ING Streetwise. Both have MER over 1.00% and don’t include any small cap tilt.

Considering the lack of choices, if one wants low fee balanced index funds in Canada, Mawer’s actively managed balanced fund is a good alternative, albeit actively managed. This is true especially for DIY investors who don’t want to deal with rebalancing a portfolio, exchange currencies, etc.

Noel January 8, 2013 at 7:50 pm

@Jas – My reference to XIU/HXT + XMD enabling a small cap tilt was in reply to the comment about Mawer having a small cap tilt. Mawer is an all-Canadian equity fund and so are the ETF’s I mentioned. Foreign small cap-tilts didn’t seem to me to be the topic of discussion, but yes it’s more problematic to achieve that.

@Dan Hallett – You misunderstand me. I do not distrust your figures at all. They appear correct but, unless I am mistaken, are the raw performance figures for the components of that portfolio. All I was attempting to say (obviously badly) is that a financial professional would tack on an annual fee (which I do not begrudge at all) for constructing such a portfolio for a client, monitoring it etc, and that would reduce the return. But, by what % I don’t know as I don’t know what fees are charged by you but I have seen as low as 0.25% per annum (when using ETFs) and up to 1%+. Assuming a DIY advisor can stay the course in terms of rebalancing, regular investing, not exiting the market when it is volatile, prudent asset allocation, etc (all of which I agree are challenges for probably most people which is why many should use an advisor) then Index ETF’s as components of a portfolio will offer the greater chance of superior performance since, over the long term, they will individually outperform most (but not all) of their actively managed peers. Is it possible for a diversified portfolio made up of actively managed mutual funds to outperform the same portfolio made up of their corresponding passively managed benchmark index funds? Of course it is. You have proven that, at least for 9 years, with that portfolio you mention in the article and probably others that you manage. Is it probable? No. The odds simply are not in favour of that.

Again, for most people the issue shouldn’t be active vs passive but consideration of all of the other aspects I mention above which, if not followed, will result in sub-par performance. In that respect, investment professionals can be key to achieving ones investment goals. But, given the overwhelming possibility of superior performance using index funds vs actively managed funds, both DIY investors who can stay the course and are not therefore challenged by the above and investment professionals will find that index funds offer the greatest possibility of superior performance in a diversified portfolio.

Oldie January 8, 2013 at 11:49 pm

@Jas: You know, I’m embarrassed to say, I don’t know what the “balanced” in the names of “balanced funds” means, and, due to the fact I was focussing on how to build portfolios from scratch from plain old index funds, I never bothered to find out. What does it mean?

Jas January 8, 2013 at 11:54 pm

@Oldie:
Nothing to be embarrassed, a balanced fund is simply a fund with a mix of equities and bonds which is auto-balanced (the proportion of each assets is kept stable, you don’t have to rebalance the portfolio by yourself)

http://beginnersinvest.about.com/od/mutualfunds1/a/What-Is-A-Balanced-Mutual-Fund.htm

Oldie January 8, 2013 at 11:55 pm

@CCP: oops, that last comment to @Jas was supposed to be in the October 1, 2012 post — I’ve been flipping back and forth and got mixed up where I was — can you wave your majic wand and redirect the comment, thanks. And while you’re at it, going back to October 1, 2012, can you re-allocate the equity portions in my portfolio and my US dollar arbitraging to reflect a healthier margin of profit back to today :)

Noel January 15, 2013 at 11:12 pm

Okay. I got this book from the library and read it. I ended up putting so many tabs on pages that I wanted to go back to in order to remember them and quote some of the things he said to others who are currently with active managers that I decided this book is just to good not to own. What a great reference book on Professional Financial Advisors and what is wrong with the entire industry.

Thanks for doing a post on it!

Patrick January 27, 2013 at 3:54 pm

@Noel: If I may leap in here uninvited, I think it’s possible you may have misread one of Jas’s statements:

“once the MER difference between active and passive management is minimal, active mutual funds have much better chances of outperforming passive mutual funds”

I believe you may have read it this way:

“Low-cost active funds are likely to outperform passive funds”

I would interpret it this way:

“Low-cost active funds are more likely than high-cost active funds to outperform passive funds”

These are two vastly different statements. I disagree with the former, and agree with the latter.

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