The Globe and Mail
Reprinted without permission

On Mutual Funds
by Duff Young

Why mutual fund substitutes are all the rage

OFFICIAL sales figures are not yet available for the RRSP season, but indications are strong that this year's grab will be much smaller than expected, despite continued low interest rates, a healthy economy and big ad spending. Some are guessing that a 30-per-cent decline from last year is possible.

The softness indicates that for the first time in seven years or so, educated investors are choosing to put less of their money in mutual funds and more in other newfangled savings vehicles.

The trend is good and bad. It reflects consumer attitudes about our industry - and provides some incentive for re-examining the way companies, design and market mutual funds.

There's always been a fringe element of investors who are so skeptical about any one manager's ability to beat the market that they invest in an index. But recent shifts have made this alternative notion of passive investing more. mainstream.

Unmanaged, or passive, mutual fund substitutes could be a good idea for a core part of your portfolio.

Evidence that stock pickers are struggling can be found in every category. Data on Canadian equities, for example, show that 84 per cent of the actively managed funds failed to match the 17.8-per-cent annual return of the TSE 300 index over the five years ended Jan. 31.

Adding insult to injury, and perhaps explaining part of the underperformance, are management fees. After all, there aren't any management fees to deduct from the index before you figure out its return. But mutual funds in Canada have high annual fees, and they're rising. (Remember, mutual fund returns, by law, are always calculated after annual expenses are deducted.) Take load funds. In 1992, the average management expense ratio for stock funds based in Canada was 2.28 per cent. Today, the same group has swelled enormously, but despite the growth, and the obvious economies of scale it should create, annual fees on these funds have actually gone up - to almost 2.40 per cent annually.

Eroding confidence further is the weakness in some of the industry's top names. Once-stellar funds from well-known families are now sporting bottom-quartile returns. So if investors can't count on the established stars to at least do better than the pack, what can they count on?

Here, then, is a list of the best passively managed alternatives to mutual funds. Each offers the diversification and pooling you've come to know and love mutual funds for. But instead of being guided by a stock picker trying to beat the market, these unique "funds" try only to be the market.

Even a skeptic would agree that some managers can clobber their benchmark - the trick is finding them. So don't put all your money in a passive strategy. Consider active management for some parts of your portfolio, like Canadian smallcapitalization holdings. There you'll find many standout managers. It's one more way you can achieve balance in your portfolio, and still keep overall fees down.

Duff Young, is president of Corp., which offers an independent portfolio repair service.