The real revolt of small investors

Forget Gamestop, AMC, Robinhood and Reddit. This is where the real small investor revolt is happening.

La Presse recently reported that Desjardins is facing a class action suit from investors who accuse it of having charged them unjustified fees on their mutual funds since 2005. Two other Canadian banks (RBC and TD) are facing the same charges.

It's about time!

Indeed, the scheme alleged in these 3 lawsuits has been known for a long time: most of the assets of mutual funds are not actively "managed". On the contrary, they simply replicate the stock market index. As far back as 1992, it was shown that 97% of the performance of the largest mutual fund in the world at the time (Fidelity's Magellan fund) was nothing more than a replication of the index[1]. Things didn't get any better after that, since in 2004, 99% of the performance of this fund was replicating the index!

Why on earth do investors tolerate being "passed a clue" when they are charged over 2% in fees? Because they simply don't know! You know how it goes: it's RRSP season and you walk into your bank branch to ask for investment advice. Your "advisor" suggests a ready-made solution for your needs: the mutual fund managed by that same bank that suits your investor profile. Of course, you are invited to read the prospectus, but it is 300 pages long! In any case, you tell yourself that if your banker suggests this particular fund, it must be the one that best serves your interests.

Wrong!

In Canada, financial institutions must offer you a product that "fits" your profile but are generally not obligated to offer you the one that is in your best interest. What is the difference? Annual fees of 1% to 2% are too high. In fact, the average mutual fund in Canada charges about 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%. Over the long term, this can mean that nearly 50% of your return is lost in fees. The difference between a comfortable retirement and a life on the balcony!

The other big question is why don't these managers try to outperform the index by actively managing their funds? The answer is just as simple: they can't! Just look at the results: 97% of Canadian equity mutual funds have underperformed the index over the past 5 years[2]. Not surprisingly, their average annual return is about 2% less than the index. This is normal: they buy the same securities as the index and charge 2% in fees.

Let's hope that the Superior Court of Quebec agrees to hear the case of these investors. In the meantime, there is no shortage of alternatives to the mutual funds of Canadian financial institutions. For the minority of investors who are truly self-sufficient, it is possible to build a diversified portfolio of exchange-traded funds at a discount broker without even having to pay a commission. For the majority of investors - those who cannot do without an advisor to develop and implement their financial plan - there are independent investment advisors who, unlike your banker, have an obligation to always act in your best interest. 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 of June 30, 2020