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Passive investing is not for everyone

Investors who are uncomfortable with the dips need a hand to hold and want someone at the rudder of their funds as well

By: KIRA VERMOND

Date: January 10, 2017

Only hours after Donald Trump’s unexpected election win in November, Judith Cane, a money coach in Ottawa, heard from her investment adviser, who was ready with prudent advice: Don’t. Freak. Out.

Ms. Cane was thankful for that guidance, as markets went into a tailspin that night, but even more so when they rebounded the next afternoon.

Yet she wonders how many do-it-yourselfers, who often rely on passive investments, fared. She was, after all, able to sit tight on her investments partly because she had someone to hold her hand.

“I don’t mind paying the fees because I think it’s worth it,” she says now. “I’m paying for this person to manage the downside, not the upside.”

Reading the news lately, you might think Ms. Cane is alone in her willingness to go the active investing route. As more investors in Canada – and even a greater percentage in the United States – eschew active for passive options, it would seem the days of financial advisers and especially mutual fund managers are numbered. Particularly with the Canadian Securities Administrators’ CRM2 initiative requiring that management fees be disclosed in dollars rather than harder-to-decipher percentages.

“Assuming people open and read their statements, they’re going to be understanding exactly how much they’re paying in fees to their financial advisers or to the fund companies,” says Noel D’Souza, a certified financial planner and money coach in Toronto.

Even so, actively managed funds aren’t going the way of the dodo quite yet.

They still win the popularity contest over passive, low-fee funds and exchange traded funds (ETFs) in this country. Although ETFs hit the $100-billion mark in the summer of 2016, Canadians have more than 10 times that amount invested in mutual funds, according to the Investment Funds Institute of Canada.

Part of the reason for sticking with actively managed funds can be chalked up to apathy or even fear of change, but that’s not the whole story. Many investors simply want to know there’s someone out there wading through data for them and trying to find the best way forward. That’s particularly true in down or volatile markets.

Take the concerns of global institutional investors who manage corporate pensions, public pensions, insurance funds, endowments and foundations. A month ago, a survey on investment outlooks from Natixis Global Asset Management indicated these investors anticipate taking on fewer passive options over the next three years because they expect a rocky road ahead for indexes.

The spectre of market volatility underlines a major downside of passive investing: What happens if your passive portfolio tanks right when you need the money for retirement?

No one can predict when the next 2001 or 2008 Armageddon will happen, but when it does, indexes offer investors nowhere to hide.

Good managers might not have a crystal ball to help them time the market, but they can read the fine print in a company’s annual report or pick up the phone and talk to its chief financial officer. And if they see trouble brewing for that company, or a whole industry or sector, they have the flexibility to pull out.

Indexes? They’re all in – no matter what.

Ms. Cane also likes actively managed funds that are rebalanced for her age and lifestyle. As she approaches retirement, more of her investments convert to fixed-income-style vehicles to keep things less risky.

“Rebalancing is the key to having a great portfolio that achieves your plan,” she says. “If a bank stock now makes up 70 per cent of your portfolio after a gain and you want it to be 50 per cent, a financial adviser says, ‘We should dial it back a bit,’” she says.

Scott Robertson, an independent financial adviser and president of Tasman Financial Services in Ottawa, says the problem with the passive approach is that many investors just can’t stomach market swings.

“In my experience, most people who say, ‘Oh, yeah, I want to be passive. I’m just going to put the money there and forget about it,’ read something in the newspaper and they’re calling me up the next day asking if they should move,” he says.

That anxiety makes sense, says Mr. D’Souza. Passive investing is a bit like hopping on a bus, riding the hills and valleys – and then plummeting down a steep bank that never seems to end. It’s even worse when you can’t see who’s steering.

“If the index drops by 40 per cent,” he says, “to see a portfolio dive at that rate, not knowing when it will stop and that no one is individually in control of it, is extremely emotionally difficult.”

Passing on passive

Do you prefer to embrace active management over passive? Noel D’Souza, a certified financial planner and money coach in Toronto, and Judith Cane, a money coach in Ottawa, offer suggestions for investors.

Look at the track record: Ask how a fund manager and his or her firm have performed over years and even decades. “They always say past performance is not a guarantee of future performance, but the past is all we have to go on,” Mr. D’Souza says. Few managers will beat the market every year, but are they consistent with their management investment style? And has their plan actually worked most of the time?

Keep an eye on costs: Everybody needs to be paid, but if a manager is underperforming and you still find yourself shelling out hundreds or thousands of dollars a year for the privilege of losing money, it’s time to come up with a new plan. “If you’re paying high fees for a couple of years, that’s one thing. But if you’re paying high fees for 40 or 50 years, that’s a huge difference for your potential nest egg,” says Mr. D’Souza.

Go fund by fund: Be picky when you examine funds. If you are working with a firm that also sells them, be aware that you don’t have to go with it for all your investments.

Speak up: It makes sense to pick a manager who does well overall, even if every single fund isn’t hitting its target. Even so, don’t be afraid to voice concerns about lacklustre funds right from the beginning, says Mr. D’Souza. “Managers have to be aware that their investors are not happy with their performance in certain areas so they can have the opportunity to make a change.”

Stay strong: Just because everyone else at your latest dinner party is jumping on the ETF and passive investing bandwagon, that doesn’t mean you have to follow suit. Particularly if your active plan is working and your manager is consistently beating the market, explains Ms. Cane. “Warren Buffet, he’s a firm believer in managing your own, or active management. And I’ve got to say, I trust him.”

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