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: