Categories
ETFs and Funds Investing

Ignore Your Canadian Fund Manager’s Historical Performance

The number one gimmick investment fund marketers use to sell their products is a strong performance track record. Historical performance is considered a staple piece of information by fund marketers and unitholders, as it makes the product appear more tangible.

Unfortunately, historical performance is useless when evaluating a fund.

You’ve probably seen the following disclaimer along in most investment funds marketing:

“Historical performance are not indicative of expected future returns and may not be repeated.”

This disclaimer is there for a reason. It is added to marketing materials because the regulators know that funds are sold based on historical returns, so they want it to be clear that past performance has nothing to do with future performance.

Even if all aspects of the fund – the manager, the style, the investment policy guidelines – remain the same, the vast majority of strong performance is fleeting in nature and cannot be repeated. Managers can get lucky streaks that result in periods of outperformance. However, few have genuine skill and are unable to repeat this outperformance consistently.

The empirical evidence supports this.

In its report called “Persistence Scorecard”, Standard and Poors regularly provides data on the persistence of investment manager outperformance. On July 15, 2020, for the first time, S&P has calculated this for the Canadian market.

The Persistence Scorecard attempts to distinguish luck from skill by measuring the consistency of active managers’ success. The inaugural Canada Persistence Scorecard shows that, regardless of asset class or style focus, few Canadian fund managers have consistently outperformed their peers.

For example, across all seven categories we track, none of the equity funds in their category’s top quartile in 2015 maintained that status annually through 2019. If we consider funds in the top half of 2015’s performance distribution, in six of the seven categories fewer than 5% of funds maintained their performance over the next four years. Coin flippers had higher odds of success.

In general, very few Canadian investment managers have demonstrated that periods of outperformance were due to skill and could be repeated.

Lengthening the horizon to consider performance over two consecutive five-year periods, the top-quartile domestic equity funds of 2010-2014 had little luck maintaining their top-quartile status during the 2015-2019 period. Only 30% of them managed to beat the median while 23% ended up in liquidation or had a style change.

While there may be a handful of investment managers that possess the skill to consistently outperform the market, it is impossible to identify these people in advance. The evidence shows that the vast majority of investment managers cannot repeat periods of outperformance. Yet these active investment managers charge 2.5% for the pleasure of their underperformance.

Consequently, investors would do much better by using low cost index funds and instead focusing on managing their investing behaviour, savings rate, debt, taxes and asset allocation.

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Categories
Work

I’m Shocked This Money Myth Still Exists

I’m shocked at how frequently people make this money mistake.

I’m referring to a common misunderstanding of how income tax rates work.

Many people say some variation of the following: “You don’t want a higher income because you’ll jump up into a higher tax rate and end up actually taking home less money after tax.” People have even refused career advancements based on this misconception.

This line of thinking is pure poppycock. Hogwash. It’s a fundamental misunderstanding of how marginal tax rates work.

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I can understand why people make this mistake. After all, marginal tax rates do increase as you earn more income. What people don’t understand is that the higher marginal tax rate ONLY applies to the income earned above certain thresholds.

To help illustrate, here’s a simple example: Let’s say the marginal tax rate on the first $50,000 earned is 20%, and above $50,000 the marginal tax rate jumps to 25%. Based on this tax structure, if you earn $70,000 you pay 20% tax on the first $50,000 and 25% tax on the next $20,000.

What people mistakenly assume is that once (using the above example) they earn above $50,000 they’ll pay 25% tax on everything.

Simply put, regardless of higher marginal tax rates the more income you earn the more you take home after tax.

A Real-Life Example

The four tables at the bottom of this post provide real-life examples of this for residents of each of the ten provinces in Canada. The detailed tables show after tax income, average tax rate, marginal tax rate, etc. on income levels of $50,000, $75,000, $100,000 and $125,000. For the purposes of this exercise, the only column you need to pay attention to is the ‘After-Tax Income’ column.

In case you don’t want to go through each detailed table, I’ve summarized the results for an Ontario resident below. Here are the after tax incomes for all four income levels:

Income: Before and After Tax for Ontario Resident

Income Before TaxIncome After TaxMarginal Tax Rate
$50,000$41,94029.65%
$75,000$59,52729.65%
$100,000$75,78743.41%
$125,000$89,93543.41%

As you can see, as you earn more income you take home more after-tax money, despite a higher marginal tax rate.

Categories
Investing

Ignore The ‘Experts’

If you’re like most people, you listen to the experts: Economists and investment managers. If there’s anything these folks are good at it’s making predictions about the future and then eloquently explaining why their predictions didn’t come true.

Economics is a pseudoscience that relies on unrealistic models that tend to be completely detached from reality. In case you don’t believe me, below is a list of projections made by various economists and investment managers over the past decade. All of these predictions proved false.

So next time you read a headline or hear a soundbite about the near-term direction of the economy or markets, treat it as background noise.

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So who should you listen to? There are good economists and investment managers. They are the ones who are skeptical about their own conclusions. They tend to have a long view that ignores the day-to-day and week-to-week fluctuations. Instead of making overconfident predictions, they provide a framework for decision making by observing the world around them.

Source: JP Morgan Asset Management