Report says that fees make it hard for active fund managers to beat the index
Most active Canadian equity funds underperform a key measure of domestic large, mid, and small-cap stocks, according to a new report.
Morningstar Canada’s analysis of active fund performance starts in June 2007 - when the Canadian Investment Funds Standards Committee determined that the Canadian Equity category was for funds with at least 90% of their equity holdings in Canada – and runs to September 2024.
It found that over the 17 year period less than one in five of these funds outperformed the Morningstar Canada Index in terms of gross returns.
This is not unusual, the firm says, with similar studies in other markets also revealing how hard it is to beat an index, but it highlights a common anomaly in the Canadian market with funds underweight energy and materials stocks, while tending to favour consumer discretionary and staples sectors.
Commodities are not only key elements of the Canadian economy and heavily represented in the index, but the analysis found that long-term underweighting of the energy and materials sectors produced limited gains during recent periods of sector strength. This was not the case for a time in the early 2010s, but since 2020 energy stocks have rebounded significantly.
Some managers had short-lived success between 2013 and 2018, when over 50% of Canadian equity funds managed to beat the index. However, rougher patches were seen before and after this period.
The report emphasizes the importance of commodity exposure for investors setting return expectations for Canadian funds.
Authors Michael Dobson and Luke Richardson, CFA, manager research analysts emphasize the importance of understanding fund allocations: “Investors should be aware of how a fund allocates to energy and materials when setting up expectations,” they state.
The report also considers the impact of fees on the performance of Canadian active equity funds, revealing that with a fee of just 1% only one in ten of the funds would beat the index, cutting the odds of outperformance in half.
Morningstar notes that Canadian equity managers, like their US and European counterparts, often struggle to exceed benchmarks due to fees.
