Risk of Large Mutual Funds

When you own a mutual fund that is so large that it doesn't just follow the market, it is the market, you are better off holding a low MER index fund or ETF.  A great review of the top 10 Canadian equity funds by assets showed the risks of owning them:
  • 9 out of 10 funds trailed the index (5 out of 10 funds of them trailed by more than 10%).
  • One fund beat the index by 2%, and no fund beat the index by more than 10% over five years.
  • Half of them dropped out of the top 10 Canadian Equity Funds (by assets) of over the 5 year period.
The average MER was 2.4%, so its no wonder that with that much coming off the top that large funds cannot possibly get ahead.  Returns demonstrate a reversion to the mean market (the index) when your holdings actually represent the mean market, and the fees put you in the hole.  

Mutual funds that have at their core a strategy that outperforms the index are one alternative.  Dimensional Funds is one example that offers increased exposure to small issuers and value securities - the parts of the market that research has shown beat the index over time.  Check out their library page to dig more into the details including observations, opinion, and links from financial economists Eugene Fama and Kenneth French.

Take the Dimensional Canadian Core Equity Fund as one alternative - the MER is a reasonable 1.55% and if you hold it at Questrade in a large portfolio, the Mutual Fund Maximizer Rebate could put 0.9% of that back in your pocket.  The net fees would be 0.65% which is lower than something like iShares' Canadian Fundamental Index Fund, an ETF that tracks the FTSE RAFI Canada Index. 

Mutual funds can offer time savings to you relative to trading stocks and ETFs, whether that is over the year or simply at tax time - and your time is money (directly or indirectly through opportunity costs).  If you avoid large funds and find those with winning strategies with low fees, then mutual funds can have a place in your portfolio.