Balanced vs Bench Better?

Just over two years ago I wrote A Balanced Perspective on Balanced Funds on the performance of Canadian balanced funds compared to their benchmark. I focused on the longer-term results over 3, 5, and 10 year periods, looking both before fees and after fees. I thought the time frame was interesting back then because the end date was March 2020, the previous bear market. Given the massive rally that happened after that, and the bear market we are in now, I have revisited how Canadian balanced funds are doing in terms of keeping up with or exceeding their benchmark returns. Have they been able to add extra return through the big ups and downs in the markets?

Revisiting Looking Through Rose Coloured Glasses

I updated the Canadian balanced fund returns from the RBC Investor & Treasury Services’ Pooled Fund Survey[1] with data to the of June 2022. The data is reported on a pre-fee basis given its institutional audience. But for an individual investor it is looking through rose coloured glasses as it is not the net return an investor receives. I compared the pre-fee returns to an institutional quality benchmark (40% bonds/60% stocks) with a 2% weight in Canadian treasury bills, 38% in Canadian bonds, 30% in Canadian stocks, 15% in U.S. stocks, and 15% in international stocks.

Chart 1 shows the results for the median Canadian balanced fund (half of funds do better, half worse) for the last 3, 5, and 10 years vs the benchmark. The black and grey bars are the results from the previous blog (data as of Q1/2020) and the dark green and light green bars show the current data (data as of Q2/2022).

Even though we are going through another bear market since the last results (Q1/2020), the returns for the median balanced fund and the benchmark are higher in the 3, 5, and 10 years ended Q2/2022. This is because of the large positive returns between the end of the previous bear market in 2020 and the peak of the bull market in January 2022. On a pre-fee basis, once again the median balanced fund outperformed the benchmark. But what about after fees?

Chart 1

Source: RBC Investor & Treasury Services, Wayfairer Capital Management

Looking Again Through Corrective Lenses

Now that we have seen the best-case scenario of pre-fee returns, lets add the corrective lens of looking at after-fee returns. To make it a fairer comparison I subtracted 1% from the balanced fund returns as that is the average fee someone with $1M in investable assets pays for active management[2]. I also deducted 0.25% from the return of the benchmark to make it comparable to the returns of a low-cost ETF portfolio, self-managed through an online platform, which matches the benchmark components. This is the adjusted benchmark.

In an ideal world the median balanced fund, after fees, should outperform the adjusted benchmark to reflect the skill of the investment team managing the fund. As we see in Chart 2 below, it isn’t always the case. The blue bars show that the median balanced fund outperformed marginally over the last 3 years and underperformed over the last 5 years. Encouragingly, it added about 0.4% over the last 10 years. The good news is that these results are much, much better than when I did my blog two years ago. Back then the median balanced fund underperformed over all the time frames, ranging from 0.4% to 0.8% lower than the adjusted benchmark. If you are lucky enough to have been in a 1^st quartile balanced fund[3] (black bars) they did their job admirably, adding anywhere from 0.76% to 1.15% return. In the previous blog they underperformed the adjusted benchmark slightly over 3 and 5 years and added only 0.2% over 10 years. While 4^th quartile managers also did better, it meant they underperformed by less!

Chart 2

Source: RBC Investor & Treasury Services, Wayfairer Capital Management

The Takeaway Is Clear

After looking at the after-fee returns of Canadian balanced funds vs the adjusted benchmark it is clear that the funds have done better than in the previous blog. This is good news for active management as it has been a difficult market (bull and bear markets) over the last ten years. It is reassuring to see that the top Canadian balanced funds (1^st quartile) are thriving and adding significant value. But the median balanced fund is only generating returns around the level of the adjusted benchmark. So, let’s hope if you have one of these funds the advice and service you are receiving is of value. And for the 4^th quartile funds, let’s just say it may be worth reviewing the fund manager’s investment philosophy, process, and team. That doesn’t necessarily mean you should make a change, as their approach may just be temporarily out of sync with the markets and could be due for a rebound.

Invest wisely,

Dave Schaffner, CFA

Principal, Wayfairer Capital Management Ltd.

[1] Each quarter RBC Investor & Treasury Services’ Pooled Fund Survey compiles the pre-fee returns of over 90 asset managers (primarily Canadian) covering 700 high quality funds that are available to Canadian institutional investors.

[2] If a balanced fund is held in a taxable account the 1% fee may be tax deductible, making the net fee smaller and increasing the outperformance, or reducing the underperformance, of the balanced funds in Chart 2.

[3] A 1^st quartile balanced fund had a return in the top 25% of reported funds and outperformed the adjusted benchmark by the amount shown or more. A 4^th quartile fund was in the bottom 25% of returns and underperformed the adjusted benchmark by the indicated amount or more.