Equity managers generally belong to one of two distinct camps: active and passive. But there’s a third, small but thriving camp that blurs the lines.
These managers are something of a hybrid between active and passive. They employ quantitative methods and rules-based approaches, like index funds. But they try to outperform conventional indexes, not simply track them. Their fees tend to be higher than passive indexers, but lower than true active managers.
Performance has been good too. In the Canadian equity category, enhanced indexing strategies have generally produced above-average risk-adjusted returns.
Among the niche players is Oakville-based Pro-Financial Asset Management Inc., which has roughly $210 million in mutual fund assets under management. Its funds are based on the FTSE RAFI Research Affiliates (RAFI) indexes, a joint venture of the London-based FTSE Group and California-based Research Affiliates LLC.
The FTSE RAFI Canada Index is the underlying index for Canadian equity funds offered by three companies, including Pro-Financial. The methodology is designed to measure the economic footprint of each company, ranking them by a combination of sales, cash flow, gross dividends and book value, rather than by market capitalization.
Pro-Financial founder and CEO Stuart McKinnon says fundamental indexing “strips away the emotional factor” of stock market sentiment in evaluating companies. “By doing that, you get a better risk-adjusted return over the long term,” he says.
The oldest, and cheapest, of the RAFI Canada-based funds is Claymore Canadian Fundamental Index ETF, offered since February 2006 by the exchange-traded-funds manager Claymore Investments Inc. For the common shares, the management expense ratio is just 0.69 per cent.
That compares with 1.88 per cent for Class A and 2.07 per cent for Class B for the nearly four-year-old PRO FTSE RAFI Canadian Index Fund, and 1.74 per cent for the newest fund, the year-old PowerShares FTSE RAFI Canadian Fundamental Index Class.
Pro-Financial’s and PowerShares’ higher MERs reflect in large part the trailer fees that they pay to advisors. But here too, Claymore is a competitor. It offers a higher-fee (MER 1.44 per cent) advisor class version that pays an annual 0.75 per cent trailer commission.
Funds based on the FTSE RAFI Canadian Index aren’t the only available choices for enhanced index funds in the Canadian equity category. The giant RBC fund family’s contender is RBC O’Shaughnessy All-Canadian Equity, launched in January 2007.
It’s managed by a Connecticut-based firm headed by Jim O’Shaughnessy, and bearing his name. His models seek to identify stock characteristics associated historically with above-average returns over long periods of time.
In the case of RBC O’Shaughnessy All-Canadian Equity, examples of the managers’ favoured characteristics include low price-to-sales ratios, strong stock-price momentum and high dividend yields.
Through RBC’s multi-channel distribution network, investors have a range of pricing options for this fund. The cheapest, with an MER of 1.16 per cent, is Series D, available only through the discounter RBC Direct Investing and fund dealer PH&N Investment Services.
Another notable alternative to conventional indexing is Dimensional Funds Advisors Canada, whose funds are distributed exclusively through financial advisors. DFA Canadian Core Equity, which began in June 2004, invests in the broad market but with a tilt toward small-cap stocks and value stocks.
For this DFA fund, the multi-factor model creates a holdings list exceeding 500 names. That compares with about 200 for the RBC fund and 70 for funds based on the much more focused FTSE RAFI Index. This suggests that, at times, we can expect performance of the various funds to also differ significantly.
Reproduced with permission - Torstar Syndication Services
