Podcast 9: Finding Common Ground

Does the whole “active versus passive” debate miss a key point about what leads to successful investing? Why do investors focus on “mutual funds versus ETFs” when neither structure is inherently superior? These are some of the topics I discuss with Tom Bradley in my latest podcast:

Tom is the co-founder and president of Steadyhand Investment Funds, based in Vancouver. Steadyhand believes strongly in active management: they even call themselves “undex funds,” because their goal is to look like nothing like the benchmarks. But if you spend any time reading Tom’s articles in the Globe and Mail, MoneySense, and on the Steadyhand blog, you’ll notice there a surprising amount of overlap in our messages. I noted this some six years ago when Tom released the first edition of his book, It’s Not Rocket Science.

Tom and I both understand that, whatever your specific strategy happens to be, the fundamental ingredients of a successful plan are low cost, broad diversification and a disciplined strategy you will adhere to over the long term. This message can get lost in the debate about indexing versus active strategies, and especially in the discussions about the relative merits of ETFs versus mutual funds.

Later in our conversation, we discuss the SPIVA scorecards, created by S&P Dow Jones to compare the performance of actively managed mutual funds to popular index benchmarks. The SPIVA results are often quoted in the media as evidence of the failings of active funds: for example, the 2016 report for Canada found that fewer than 9% of broad-market Canadian equity funds beat their benchmark over 10 years, while for U.S. equity funds that number was a big fat zero.

Tom explained some of the potential flaws in the SPIVA methodology: most significant is that they ignore currency hedging in foreign equity funds, which can distort the results dramatically.

The Couch Potato goes to work

In the Ask the Spud segment, I answer a question from a reader named Phil, who is being offered an employer matching program in his group RRSP. If he contributes 5% of his salary, the company will add another 5%. “I’m concerned I’m going to be stuck with a bunch of high-cost mutual fund options or actively managed portfolios,” he writes. “I assume I’ll be still be further ahead if take the advantage of the 5% match, but how do I make the best out of the less-than-ideal options I have?”

I’m a big fan of using employer-sponsored retirement plans—including defined contribution pensions as well as group RRSPs—because they encourage disciplined savings and hands-off investing. Unfortunately, group plans tend to be sponsored by large mutual fund or insurance companies and some offer only active funds, often with relatively high fees compared with an ETF portfolio.

But if you get a significant company match in your employer-sponsored plan, I suggest taking full advantage. Even if the funds have relatively high fees—say 1.5% or even more—the employer’s contribution will usually more than make up for the added costs.

In my answer to Phil’s question on the podcast, I suggest the following steps to get the most out of your group RRSP:

See if there are index fund options. It’s actually common for group RRSPs and defined contribution pension plans have index funds on the menu—at least for some of the asset classes. If that’s the case, you can assemble your portfolio using whatever index fund options are available. For example, if you plan to use a traditional balanced portfolio of 60% stocks and 40% bonds, you can instruct your plan provider to allocate 20% each to the Canadian, US and international equity index funds and 40% to the bond index fund.

Look for focused, well-diversified active funds. If you don’t have an index fund option for a particular asset class, look for an active fund that most closely resembles one. For example, if there is no index fund for US equities, there’s probably one that holds 50 or 60 blue-chip companies with all of the sectors represented. A fund like that is likely to be highly correlated with an index fund that tracks the S&P 500.

Contrast that with other funds that might be offered by your plan: maybe there’s a healthcare fund, or a technology fund, or a “global opportunities” fund, whatever that means. None of these are likely to behave anything like an index fund, so they are not appropriate.

Consider target date funds. Created specifically for group plans, target date funds are balanced portfolios of stocks and bonds in various proportions, from aggressive to conservative. The funds get gradually more conservative as the target retirement date approaches. If you plan to retire in 20 years, for example, you might choose a fund with a target date of 2035. Today it might hold 70% or 75% equities, but by 2035 it will be primarily in bonds and cash.

Many group RRSPs and pension plans include target date options from Fidelity’s ClearPath or BlackRock’s LifePath family. These can be an excellent option—especially the BlackRock options, which  are made up of underlying index funds.

Transfer the money to a self-directed RRSP occasionally. Many group plans allow you to enroll in an employer matching RRSP and then then transfer the funds to an external account. Sometimes they charge a fee for this, but in many cases you can do it for free once or twice a year.

I feel this makes sense only if your group plan has exceptionally high fees or terrible fund options, or if your RRSP savings are very large. Otherwise making regular transfers might be more hassle than its worth.

 

9 Responses to Podcast 9: Finding Common Ground

  1. Justin June 17, 2017 at 1:42 pm #

    Another great podcast! Regarding lack of options within group RRSPs, if you consider all of your accounts as one large portfolio, you don’t necessarily have to hold all asset classes in the group RRSP.

    For example, if your group RRSP offers Canadian and US equity index funds but not a bond or international equity index fund, you could hold only Canadian and US equities in the group RRSP. You would then adjust your holdings in other accounts so that your overall portfolio is aligned with your overall target asset allocation. I think this is a better strategy than choosing a closet indexer in the group RRSP, but I suppose not everyone has savings outside of their employer-sponsored accounts.

  2. Dan June 18, 2017 at 12:53 am #

    Great Podcast. I have thoroughly enjoyed the series.

  3. Tristan June 18, 2017 at 5:29 pm #

    CCP: Thanks for another very interesting podcast. I find it interesting that Tom acknowledges the importance of low cost, yet uses an active strategy, which must be more expensive due to the extra work and manpower required, costs which must be passed on to their clients. If Steadyhand instead used low cost ETFs for portfolio management, in which case they could lower their fees still further, wouldn’t they provide still better outcomes for their clients?

    I would take issue with Tom’s claim that 20 stocks provide adequate diversification. That used to be thought to be true, but more recent evidence indicates the number is closer to 100, especially for US and international markets, as discussed here.

    http://mutualfunds.com/expert-analysis/portfolio-diversification-how-many-stocks-are-enough/

  4. Canadian Couch Potato June 19, 2017 at 7:35 am #

    @Justin: Thanks for the comment. It’s true that you can hold only one or two asset classes in a group plan and compensate with the others in self-directed RRSP. But this can make things challenging when it comes to rebalancing because most group plans only allow you to set a target percentage for each asset class. In my experience it is easier for investors to simply hold all of the asset classes in their group plans so they don’t have to worry about rebalancing.

  5. Duchess June 19, 2017 at 5:20 pm #

    Long time commenter, first time listener. Great podcast as usual. I have a question for the next episode: My bank keeps calling to tell me I have an outstanding balance, but they sound angry about it. I don’t understand.

  6. Canadian Couch Potato June 19, 2017 at 7:38 pm #

    @Duchess: Perhaps your credit rating has slid into the DANGER ZONE.

  7. rgz June 21, 2017 at 2:05 pm #

    Will you concede that for some people, funds such as SIF125 and MAW104 might be more suitable than the model ETF portfolios you have on your website?

  8. Canadian Couch Potato June 21, 2017 at 2:14 pm #

    @rgz: I think the comments I made in the blog post and in the podcast make it clear that a prudent, low-cost active strategy is more appropriate for anyone who does not feel confident in an indexing approach. If you don’t have confidence in your strategy, you will never stick to it during the difficult times. I just stop well short of naming specific active funds as alternatives.

  9. vslcar June 21, 2017 at 11:30 pm #

    Hi Dan,

    You said that Cash has lower yields than Bonds. I would argue that this is not necessarily true as there are several CDIC insured Canadian banks that offer high interest savings accounts. EQ bank is currently offering 2.3% interest indefinitely and I have been able to get 3%+ with Tangerine bank for the last year thanks to their recurring 3 month targeted promo rates. Great podcast. Cheers!

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