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ETFs just underwent a stress test - here's how they did

One of the knocks on being an index investor is that you're vulnerable in a fastfalling stock market.

Most of the assets in exchangetraded funds track benchmark indexes in which stocks are weighted according to their market capitalization - shares outstanding multiplied by share price. The stocks that investors push up the most in price can dominate the index. If these stocks fall hard in a decline, the index gets crushed. The inference here is that you're better off with actively managed money, where an investing pro can build a portfolio for you that may not be so tied to the stocks that have risen the most in price.

The recent market turmoil offers the opportunity for a quick and dirty look at whether index investing actually has more downside in falling markets. For a comparison of indexing and active management, let's look at the returns of the biggest Canadian equity funds of all types for the trading week to Feb. 5 (including the plunge on the 5th).

The biggest Canadian equity fund of any type is the iShares S&P/TSX 60 Index ETF (XIU), which fell 4.7 per cent over that period. Another big ETF is the third-ranked iShares Core S&P/ TSX Capped Composite Index ETF (XIC), also down 4.7 per cent.

A few returns for comparably large Canadian equity mutual funds for the same time frame supplied by TD Canadian Value Series I: down 4.6 per cent.

BMO Canadian Equity Fund Series A: down 4.7 per cent.

RBC Canadian Equity Series A: down just under 5 per cent.

MFS Canadian Equity: down 4.4 per cent.

Fidelity True North Series B: down 4.2 per cent.

Of course, a week offers only a sketchy idea of how a fund performs. But the past seven days were among the worst in years for stock markets. Consider this period as an opportunity for a surprise inspection to see how funds perform under stress. The average decline for our half dozen equity mutual funds was 4.6 per cent, marginally less than the index. So, yes, some actively managed funds did avoid the worst of the recent market plunge, if only by a little.

The more telling comparison is over a period of 10 years or more. That's long enough to include the stock market crash of 2008-09 and calendar-year Canadian market declines in 2011 and 2015. XIC averaged 4.8 per cent annually over the 10 years to Dec. 31, while XIU averaged 4.9 per cent. Of the equity funds listed above, none equalled those returns (BMO Canadian Equity was very close). Index investing may in some cases offer a slightly rougher ride in the short term, but the long-term results look good.

© The Globe and Mail

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