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Rogers Group Financial (RGF) publishes a quarterly newsletter, The Financialist, which is written by the advisors of our firm. The articles are aimed at providing meaningful information relevant to the specific needs of our clients, and each covers a variety of topics (including specific investment strategies and the details of individual investment products).  The latest issues of The Financialist are below; for a complete archive and access to printable .pdf articles, please click here

Passive Investing…These Aren’t Your Parents’ Index Funds Anymore!

The Financialist • Issue 128 • January 2016


By definition, passive investing is best described as an investment strategy that tracks a market-weighted index or portfolio. The idea is to minimize costs and twhile tracking a broad market’s performance.
Passive or index-based investing has been around since 1970, starting with the introduction of the Qualidex Fund Inc., an index fund based on the Dow Jones Industrial’s 30 stocks. From 1970 and virtually straight through and uninterrupted to today — much has been written about passive vs. active investing.

In the past, the simplicity of an index-based strategy was both its strength and its weakness. A portfolio was built using a widely-held basket of securities that, according to opinion (which was not always agreed upon by investors), represented a particular sector of the market, or in some cases, a whole market. The basket was “market-weighted” which means that the stocks that make up an index reflect the same percentages as they do on the market. Put another way, if Royal Bank made up 7% of the S&P/TSX 60 index then, using a market-weighted approach, Royal Bank should make up 7% of the index fund. This is a simple way to participate in the market, using the same strategy as if you had enough money to buy each individual stock that makes up an index, in the exact same weightings.

The problem came in later, where a stock or a group of stocks in the same industry or sector began to take a larger share of the pie because their market weight had grown at a faster pace than other stocks within the index. Some refer to this as the “Nortel Effect”. While Nortel was a going concern, the technology bubble of the late 1990s propelled it to make up close to 35% of the TSE 300 index, which represented the largest 300 companies on the Toronto Stock Exchange at the time. From 1998-2000, Nortel accounted for almost ¾ of the 86% rise in the TSE 300! Then, the tech bubble burst. By March 2001, Nortel’s steep decline was to blame for… guess what? ¾ of the TSE 300 index’s 32% decline!

This was the weakness of passive investing; investors allowed the balance of their portfolios to be grossly overweight based on emotional market factors rather than valuation analytics.

Since then, investment management companies have built a wide array of passive products trying to capture market share and offer a greater breadth of products to investors, while trying to avoid another “Nortel Effect”. Everything from index-linked term deposits; principal guaranteed index funds to sector-biased and even leveraged-based passive portfolios were built. While these were interesting iterations, there was still a long way to go.

It wasn’t until the past few years when investment management companies have made real strides in offering investors truly innovative ways to participate in the market, in what I would call “quasi-passive” ways. Today, there are wide arrays of exchange-traded funds and index-based funds that, while they offer many of the same positive features of the original passive strategies, have added varying levels of active overlays, allowing for such features as equal weight vs. market weight, where a stock or a sector cannot make up more than a certain percentage of the portfolio. Some offer “intelligent indexing” where the ETF is more actively managed, focusing on earnings, dividend rates or where we are in the economic cycle, rather than just the size and liquidity of a company. There are also funds that, while they are not purely index-based, they are structured in a similar format. Based in academia, these funds are built and managed using historic and recent groundbreaking research on economics, finance and market efficiencies to achieve impressive, long-term returns.

If you would like to know more about passive investing and different strategies using both passive and active investing, please do not hesitate to talk to your Rogers Group Financial advisor or your advisory team.  
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