It's another lump of coal this Christmas for most Canadian equity fund investors.
2012 marks the fifth consecutive year the value of the average Canadian stock fund is below levels right before the global financial meltdown of early 2008, when the TSX Composite Index lost nearly half its value in three months.
The typical investor is still under water with losses that translate into 1.3 per cent each year. In other words, if you invested in a Canadian equity fund at least five years ago, you may be paying your fund manager to lose your money.
The average Canadian equity fund charges investors 2.5 per cent of their total investment each year in the form of a management expense ratio (MER). Canada has traditionally had the highest mutual fund fees in the industrialized world but when annual gains were near double digits over a decade ago, a fee of 2.5 per cent was easier for investors to swallow. Now a 2.5 per cent fee could mean the difference between making and losing money. Other fees like front and back end loads can pull your investments down further.
MERs are imposed by mutual fund companies to cover their costs including skilled and experienced managers who decide which stocks, and how much of those stocks, are in the portfolio. In theory, the biggest benefit from an active manager is risk management — the ability to steer clear or minimize the impact of traumatic market events like the 2008 meltdown.
Those costs can get pretty high for international funds but Canadian fund managers have their work cut out for them because there are so few large publically-traded stocks in this country. Roughly one-third are resource related and another third are finance related.
Looking at the top holdings in most Canadian equity funds is like déjà vu - the big five Canadian banks, big oil and gas producers and big mining companies that are familiar to many Canadians.
Canadian equity funds use the TSX Composite Index as a benchmark, which means they also bear an uncanny resemblance to the index. The big difference being the TSX Composite has posted an annual gain of 0.7 per cent over the past five years — curiously similar to the average Canadian mutual fund if you strip out the MER.
In retrospect, investors would have been further ahead to invest in an exchange traded fund (ETF) that duplicates the TSX Composite. The iShares S&P/TSX Capped Composite Index fund, for example, has returned 0.3 per cent annually over the same five years and charges an MER of 0.25 per cent.
That's not to say investment skill and experience don't count in Canadian equity funds. Many portfolio managers lost less in the meltdown, beat the index over the past five years, and charged investors much less than the average.
One example is the Mawer Canadian equity fund with an annual average five year return of 3.2 per cent and an MER of 1.23 per cent. The fund, sponsored and managed by Mawer Investment Management, has consistently outperformed the TSX Composite and the average Canadian equity fund over the past twenty years.
Another exception to the rule is the O'Shaughnessy All-Canadian Equity fund sponsored and managed by RBC Global Asset Management. The O'Shaughnessy fund charges an MER of 1.81 per cent, has returned 1.8 per cent each year for the past five years, and has a record of beating its peers and the index since its inception in January 2007.
The trick is to find the right Canadian equity fund but unfortunately mutual fund companies are not required by regulators to provide a great deal of details about their funds.
The fact remains, if you roll the dice on a Canadian equity fund the odds are in the house's favour.