ETFs vs. Mutual Funds

Recently, Rob Carrick of the Globe and Mail wrote an article in which he compares Canadian equity mutual funds to the iShares Canadian Composite Index Fund (XIC) in terms of performance over the last five years. He discovered that only five mutual funds out of about 100 beat the ETF.

Funds which beat XIC in the last five years:

1. Acuity All Cap 30 Canadian Equity
2. imaxx Canadian Equity Growth
3. Altafund Investment Corp.
4. TD Canadian Equity
5. TD Canadian Equity-A

While I would argue that you really need a longer time period and varying conditions (ie bear market) to determine if ETFs are superior to mutual funds, this study raises some interesting questions. If you have an investment advisor who tells you that they can pick top performing mutual fund managers then I would suggest you take a look this list of Canadian equity funds and if you don’t see anything familiar then maybe you should ask your advisor why they didn’t pick one of the top funds. Another good question to ask yourself is why you even need an advisor if you can pick a standard ETF and get better performance.

One of the big benefits of Exchange Traded Funds (ETFs) are the lower management costs which are typically less than 0.5% when compared to mutual funds which normally charge anywhere from about 1.3% to 3% for equity funds. Books such as Four Pillars of Investing and Random Walk Down Wall Street emphasize the fact that these lower costs result in better returns for ETF. Only a minority of mutual funds will beat their index in any given year and the problem is that very few of those funds can continue to beat the index for any length of time. Over time, broad market ETFs will beat the vast majority of mutual funds which makes it very difficult to pick the rare fund that does better than an ETF.

The problem we have as consumers is that we never see any advertising which promote ETFs (since they are low cost after all) but we get bombarded with ads from financial companies which always boast about one or two of their funds which have had superior performance in a recent time period. What you need to figure out is how many funds those companies manage and how many are they advertising? It’s usually a small percentage.