Any mutual fund that beats its benchmark is a winner, but the benchmark, rather than the winning fund, may be better for your client. Sound paradoxical? It isn’t, really.

Let’s assume that a winning fund remains a winner for the client even after tax. To beat a benchmark index, a manager must do one of two things: either over or under weight positions in the index, or hold investments not included in the index. If your winning manager is outperforming the index by holding investments not in the index, chances are that manager is being benchmarked against an inappropriate index. This is referred to as style drift or, in many cases, as outright asset class drift. In these instances, it makes sense to use a blend of indices to evaluate a manager.

Data from Wilshire and BGI’s proprietary software, PortfolioWorks, reveals that much of the value-added many managers bring to small cap funds comes from shrewdly seeding the fund with large caps when markets get rough. Another example of style drift resides right here in Canada. As you know, Canadian equity funds are allowed to hold up to 30% foreign content. It is not uncommon for a fund to hold 80% Canadian stocks and 20% in U.S. securities (According to PALTrak, as of October 31, 2002, the median Canadian Equity fund held 17.3% in foreign equities). A properly weighted “CanAm” blended benchmark rather than a purely Canadian benchmark would be a better measurement of relative performance in this case.

Exchange traded funds (ETFs) let you capture just about any index you like so your clients can consistently achieve near benchmark returns year after year. There is no style or asset class drift because equity ETFs are matched to an index, so you know exactly what your client is invested in all the time. This feature makes precise asset allocation possible, which, according to numerous studies, is the most important decision for long-term investors. So why take a chance on portfolio mix when you can give your clients today’s standards of excellence in the right proportion to ensure they reach their goals?

Sponsored by Barclays Global Investors Canada Limited Contact Howard Atkinson at howard.atkinson@barclaysglobal.com

Commissions, management fees and expenses all may be associated with Exchange Traded Funds. Please read the relevant prospectus before investing. Mutual funds are not guaranteed, their values change frequently and past performance may not be repeated. BGI’s ETFs, other than iUnits, are not qualified for distribution to the public in Canada as no prospectus has been filed for such funds with Canadian securities regulators.