The real revolt of small investors

Forget Gamestop, AMC, Robinhood, and Reddit. This is where the real revolt of small investors takes place.

We recently learned in La Presse that Desjardins is facing a class action request from investors who accuse it of having imposed unjustified fees on their mutual funds since 2005. Two other Canadian banks (RBC and TD) face the same charges.

It’s about time!

Indeed, the alleged ploy in these 3 lawsuits has long been known: the bulk of mutual fund assets are not actively “managed”. Rather, they are simply replicating the market index. As early as 1992, it was shown that 97% of the return of the largest mutual fund in the world at the time (Fidelity’s Magellan fund) was nothing other than the replication of the index[1]. Things did not improve afterward because in 2004, 99% of the return on this fund tracked the index!

Why in the world do investors tolerate passive index returns when they are charged more than 2% in fees for active management? Quite simply because they do not know it! Here’s how it works: it’s RRSP season and you walk into your bank branch to seek advice on your investments. Your “advisor” offers you a ready-made solution for your needs: the mutual fund managed by the same bank and which suits your investor profile. Of course, you are invited to read the prospectus, but it is 300 pages long! Either way, you tell yourself that if your banker offers you this particular fund, it must be the one that best serves your interests.

False!

In Canada, financial institutions must offer you a product that is “suitable” for your profile, but generally are not obligated to offer you one that is in your best interests. What is the difference? Annual fees that are 1% to 2% too high. In fact, the fees on the average mutual fund in Canada are around 2% annually, whereas you can invest in an exchange-traded fund – which essentially holds the same securities as the bank’s fund – for which the fees are as low as 0.05%. In the long run, up to 50% of your returns are eaten by fees. The difference between a comfortable retirement and life on a tight budget!

The other fundamental question is this: why aren’t these managers trying to outperform the index by actively managing their funds? The answer is just as simple: they are unable! The numbers speak for themselves: 97% of Canadian equity mutual funds have underperformed the index for the past 5 years[2]. Indeed, their average annual return is about 2% less than the index. No surprise here: they hold the same stocks as the index and charge 2% in fees.

Let’s hope that the Superior Court of Quebec will agree to hear the case of these investors. In the meantime, there is no shortage of alternatives to mutual funds from Canadian financial institutions. For the minority of investors who are truly autonomous, it is possible to build a diversified portfolio of exchange-traded funds with a discount broker commission free. For the majority of investors – those who need an advisor to develop and implement their financial plan – there are independent investment advisers who, unlike your banker, have an obligation to always act in your best interests. Join the revolt!

[1]  Measuring the True Cost of Active Management by Mutual Funds, Ross. M. Miller, Journal of Investment Management, Vol. 5, No. 1, (2007), pp. 29–49

[2]   SPIVA® Statistics & Reports, as at June 30th, 2020