Core Portfolio Methodology
The core portfolio methodology is to use low-cost indexation products with a focus on asset allocation to reduce the variance of portfolio returns.
Indexation versus Active Management
The Core allocation is constructed based on the principle that the reduced costs and relative outperformance of indexed investments (namely Exchange Traded Funds and Index Mutual Funds) will outperform the majority of investment portfolios constructed based on active management principles. The supporting evidence is borne out in the two studies periodically updated by Standard and Poor’s: 1) The SPIVA Scorecard (Standard and Poor’s Index Versus Active Scorecard) which demonstrated that less than 8.4% of actively managed Canadian Equity Mutual Funds could beat the S&P/TSX Composite index for the five years ending December 31, 2007 and 2) The Standard and Poor’s Mutual Fund Manager Persistence Scorecard (June 2006 edition) which demonstrated that out of all top quartile U.S. Domestic Mutual Funds (Large-, Mid, and Small-Cap), only 1.84% remained in the top quartile over five consecutive 12-month periods ending June, 2006.
Indexation Products
You cannot invest directly in an index, however you may invest in either Exchange Traded Funds (ETFs) or Index Mutual Funds to replicate the performance of the underlying indices as closely as possible. The goal of either product is exactly the same: to replicate the holdings of the index and nothing more. While each structure is vastly less expensive than actively managed mutual funds, some costs are shared between all three. Namely, there will always be brokerage costs associated with the funds buying and selling the securities that make up the index, administrative fees for reporting measures and advertising, etc. The cost reduction versus actively managed funds is accounted for by the lack of compensation awarded to an active fund manager and his or her research and analysis staff for security selection, in addition to embedded compensation to the fund distributors. The brokerage costs, administrative fees and marketing expenses pale in comparison to active mutual funds. Khorana, Servaes and Tufano (2007) noted that the average Canadian Equity Fund has an MER of 2.41%. Contrast this to an ETF that tracks the Canadian stock market which has an MER of 0.25%. The differences in MER would represent an annual savings of $2,160 per $100,000 invested for investors not requiring a financial advisor, or using a discount brokerage account in conjunction with fee-only financial advice where the cost of advice is not tied to the account, but rather charged separately. For ETF investors using a fee-based advisory account with a 1.00% Client Advisory Fee, the annual savings versus the average Canadian Equity Mutual Fund would be $1,160 for Registered Accounts and $1,624 for Non-Registered Accounts for which the Client Advisory Fee may be tax-deductible (assuming top Ontario marginal tax rate of 46.41%).
