The argument for buying ETFs is a pretty easy one. Because of lower fees and products that track the index instead of trying to beat it, ETFs as a whole do better than mutual funds.
Sure, the argument goes, a fund manager could beat the index–at least in theory. But over the long haul, any skill the manager might have gets eaten away in fees and something called window dressing. Basically, a fund manager doesn’t want investors to know they own dud stocks. So those stocks get punted out and replaced with sexier names trading at higher prices.
Buying high and selling low isn’t really a good recipe to investing success.
However, after saying all that, I won’t completely write off the mutual fund industry. There are a select group of funds have been terrific investments over the years and should continue to outperform the market going forward. Yes. Really.
These funds aren’t easy to find, but they do exist.
Becoming a good mutual fund investor
There are certain types of investments that benefit more from active management than others.
Take the world of small-cap stocks as an example. Many people follow Suncor or Imperial Oil, Canada’s two largest oil producers. Very few follow drilling company Akita Drilling, a company 99% of you think I just made up. Yet there are compelling reasons to buy the latter over the two former companies.
This is an area of the market where a smart manager can really make a huge difference. They can pick up cheap stocks, hold until other investors figure out the opportunity, and then sell when things get higher.
Take the Mawer Global Small Cap Fund for instance. It has been around since 2007, and has pretty much trounced the market since inception by following such a strategy. If you would have invested $10,000 in the fund when it opened, you’d have nearly $30,000 today. That’s compared to an investment in the TSX Composite Index, which would be worth about $11,500 today.
That’s a difference of…carry the one…a lot. This Mawer fund has killed just about every index fund during its existence.
The fund’s top holdings are littered with names unfamiliar to the average investor. Bank of Hawaii Corp. DCC PLC. PayPoint PLC. Amsterdam Commodities NV. I swear, these companies really exist.
Even though this fund charges investors a 1.74% annual fee–multiples higher than Vanguard or iShares charge for even their most expensive ETFs–it’s cash that has been worth every penny for investors.
The only disadvantage to this fund? You’ll need a minimum investment of $5,000 to get a piece of the action.
The Mawer fund isn’t the only terrific mutual fund out there in Canada.
Back in 2000, small-time asset manager Norrep launched the Norrep Fund. If you would have put $10,000 in this fund on inception date, your investment would be worth nearly $86,000. That compares to the TSX Composite Index, which would have turned $10,000 into approximately $26,000.
The Norrep Fund charges a rich management fee of 2.36%. And like the Mawer fund, its portfolio is stuffed with companies the average layperson has never heard of. But you can’t argue with the results.
Should you try this strategy?
Naysayers will point out that it’s always possible to find mutual funds that do well over a period of time. A fund manager can always get lucky. After all, a broken clock is right twice a day.
These people have a point. There’s no guarantee the Mawer or Norrep funds profiled above will continue to outperform. In fact, they may even underperform going forward as returns regress to the mean.
But at the same time, I don’t think it’s something that should be dismissed completely. There’s a very clear reason for their outperformance. They continue to have the same people in charge. And luck doesn’t tend to last a whole decade.
Picking winning mutual funds is tough, there’s no doubt about it. Many people will choose not to bother, and I don’t blame them one bit. If ETFs are a fine solution, then why even try to mess around in the world of mutual funds?
But the fact is that among the many duds are some great funds that can make a lot of money. If you can find one of these funds, it might make a big difference in your net worth.