Could You Have Picked the Winning Funds?

Last month I put together the Global Couch Potato’s 10-year report card. I calculated the returns of this simple index portfolio using data from TD’s e-Series index funds, including annual rebalancing. The annualized return of the portfolio from 2001 through 2010 was 4.03%.

In a subsequent post I looked at how the Couch Potato stacked up against other globally balanced mutual funds. But at that time, the only 10-year performance data I could get was what I looked up myself in annual reports. So even though it appeared that the Couch Potato did well during a turbulent decade, it was hard to say much more than that.

While researching my column for the June issue of MoneySense, however, I collected much more complete data. I called Morningstar and asked them to provide me with the 10-year returns for all Canadian mutual funds in two categories: Global Equity Balanced and Global Neutral Equity. These categories most closely resemble the Global Couch Potato, with its 40% bond allocation and its equity holdings spread across Canada, the US and international markets.

How many of these outperformed a portfolio of humble index funds? And could you have identified these winners in advance?

This could get ugly

Warning: the following paragraphs include mutual fund data that may be disturbing to active managers. Reader discretion is advised.

Let’s begin in the Global Equity Balanced category, where Morningstar had 54 funds with a 10-year track record. The average return of the funds in this category was just 1.76%, and only five (9%) outperformed the portfolio of index funds over that period.

In the Global Neutral Equity category, the news was slightly less dreadful. Among the 53 funds in the category, the average return was 2.98%. In this case, a whopping 10 of the 53 funds (19%) beat the Global Couch Potato’s performance over the last decade.

Overall, then, 86% of 107 comparable mutual funds in Canada — about six out of every seven — were unable to outperform an index portfolio during one of history’s worst decades for equities. (Who was it that said that indexing only works in bull markets?) Remember, too, that we’re not talking about a hypothetical index benchmarks here: the Couch Potato’s returns were calculated using the real-world performance of actual funds.

It must also be noted that Morningstar’s mutual funds returns do not account for the front-end loads that are tacked on to many of these funds. Many investors in the outperforming funds would not have achieved these returns because of these additional costs.

The Couch Potato Challenge

Proponents of actively managed mutual funds like to argue that they can identify good mangers and outperforming funds in advance. To find out if this true, I’ll issue a challenge. If any advisor can produce a verifiable document from 2001 (such as client newsletter or a list of recommend funds) that contains one of the 15 outperforming funds, and they can demonstrate that at least one of their clients held that fund for 10 years, I will buy him or her a steak dinner. I’ll even throw in a potato.

Here’s the list of all 107 funds and their annualized returns from 2001 through 2010:

Source: Morningstar

Source: Morningstar