Consistently beating the market is overrated

Even phenomenal investors like Warren Buffett have off years

  6 Premium content image

by

Online only.

  6 Premium content image
(Fry Design Ltd/Getty Images)

(Fry Design Ltd/Getty Images)

If some index fund proponents are to be believed, the only good active strategy is one that consistently outperforms the market. Or, at least, on some days it seems that way.

A recently article by Jeff Sommer in the New York Times called “How Many Mutual Funds Routinely Rout the Market? Zero” helps to bolster the notion that consistent outperformance should be thought of as a goal that active funds should achieve.

What a bunch of poppycock.

Don’t get me wrong, the high fees charged by many funds generally results in their poor showing versus the market.

But the notion that a money manager is a failure when they don’t beat the market each and every year gets my goat. After all, even phenomenal investors like Warren Buffett have off years.

Even worse, there are periods when beating the market is a sign of poor money management. Stupidly risky strategies can outperform for a time before they take a dive. For instance, reckless Internet stock funds in the late 1990s gambled with their investors’ cash and eventually lost big time.

Alternately, it’s possible to criticize indexing unfairly in a similar way. For instance, how many Canadian equity index funds consistently outperformed, say, the Mawer New Canada fund over the last 20 years? Probably none, but let me know if you find one.

After all, the Mawer fund gained an average of 15.5% annually over the period according to globefund.com. At the same time the BMO Nesbitt Burns Canadian Small Cap index gained an average of only 8.6% annually and the S&P/TSX Composite gained an average of 9.2% annually.

There were periods over the decades when the indexes failed to beat the fund. But that fact alone doesn’t say much. There were other periods when the fund failed to beat the indexes.

In other words, consistency is a bit of a bugaboo. Even good strategies will have a dry spell from time to time.

When an indexing proponent warns you that active funds don’t consistently outperform the market, they’re right. But they’re probably trying to pull the wool over your eyes. That’s a shame because the argument for sensible low-fee passive investing is strong and it isn’t necessary to use a statistical slight of hand when making it.

Safer Canadian Dogs

Investors following the Dogs of the Dow strategy want to buy the 10 highest yielding stocks in the Dow Jones Industrial Average (DJIA), hold them for a year, and then move into the new list of top yielders.

The Dogs of the TSX works the same way but swaps the DJIA for the S&P/TSX 60, which contains 60 of the largest stocks in Canada.

My safer variant of the Dogs of the TSX tracks the 10 stocks in the index with the highest dividend yields provided they also pass a series of safety tests, such as having positive earnings. The idea is to weed out companies that might cut their dividends in the near term. Just be warned, it’s a task that’s easier said than done.

Here’s the updated Safer Dogs of the TSX, representing the top yielders as of March 16. The list is a good starting point for those who want to put some money to work this week.  Just keep in mind, the idea is to hold the stocks for at least a year after purchase – barring some calamity.


Name Price P/B P/E Earnings Yield Dividend Yield
BCE (BCE) $53.38 4.1 17.91 5.58% 4.87%
CIBC (CM) $92.65 2.01 12.76 7.84% 4.58%
Potash Corp (POT) $42.52 3.46 21.03 4.76% 4.56%
Rogers (RCI.B) $43.62 4.1 16.71 5.98% 4.40%
National Bank (NA) $46.31 1.76 10.6 9.44% 4.32%
Bank of Nova Scotia (BNS) $63.78 1.65 11.15 8.97% 4.26%
Bank of Montreal (BMO) $76.81 1.45 12.13 8.24% 4.17%
Royal Bank of Canada (RY) $76.27 2.14 12.13 8.25% 4.04%
TransCanada (TRP) $54.37 2.29 22.1 4.52% 3.83%
TELUS (T) $42.24 3.45 18.21 5.49% 3.79%

Notes

Source: Bloomberg, March 16, 2015

Price: Closing price per share

P/B: Price to Book Value Ratio

P/E: Price to Earnings Ratio

Earnings Yield: Earnings divided by Price, expressed as a percentage

Dividend Yield: Expected-Annual-Dividend divided by Price, expressed as a percentage

As always, do your due diligence before buying any stock, including those featured here. Make sure its situation hasn’t changed in some important way, read the latest press releases and regulatory filings and take special care with stocks that trade infrequently. Remember, stocks can be risky. So, be careful out there. (Norm may own shares of some, or all, of the stocks mentioned here.)

New & Noteworthy

Prem Watsa’s annual letter to shareholders

Mr. Watsa remains bearish. He writes, “The CAPE (Cyclically Adjusted Price Earnings) Ratio for the S&P500 is currently at 28 times. It has been higher only twice before; both times ended badly. The first time was in 1929 and the second time during the dot.com boom of 1999 to 2002. The rising U.S. dollar (with over 40% of the average S&P500 companies’ earnings coming from abroad) and the current record after-tax profit margins, combined with deflation, could result in significant declines in the earnings of the S&P500 companies – just as the index hits record highs. We say ‘caveat emptor’, and continue to be very cautious about our equity positions. I have reminded you many times in past Annual Reports of the warning from the distant past from our mentor Ben Graham: ‘Only 1 in 100 survived the 1929 – 1932 debacle if one was not bearish in 1925’.”

Just For Fun

Daylight Saving Time – How Is This Still A Thing?

John Oliver’s riff on the madness of daylight saving time.

6 comments on “Consistently beating the market is overrated

  1. The Div. Yield on POT is incorrect. Should be 3.7% as of close on March 19/15

    Reply

  2. Sorry about that. I assumed the dividend was in CAD. I don’t own POT.

    Reply

  3. Finally, someone who believes that investing isn’t just about beating an index.

    Investing is just one segment of your financial plan !

    Reply

  4. The Mawer Canada Fund is closed to new investors (has been for some time). Take a look at their other funds such as Canadian equity and Global small cap, they are also consistent index beaters.

    Reply

  5. This seems to be a straw man argument. I never hear indexers say “actively managed funds can’t beat the index consistently every year”, it would be stupid to say that. What they do say is “about 90% of the actively managed funds cannot beat a simple low-cost balanced index portfolio OVER LONG-TERM” and they’re correct, of course. :)

    Reply

    • Alex, you are correct, and in addition, there is no evidence that it is possible to pick, in advance, who these few outperformers will be, and past great performance is not an indicator of future outperformance. That is why indexing has the highest probability of success, by far, in the long term.

      Reply

Leave a comment

Your email address will not be published. Required fields are marked *