The Globe and Mail, Report on Business
Published April 18, 2009

Let me set the scene. A generic portfolio manager enters a psychiatrist's office and starts talking. Let's be a fly on the wall.

Thank you for seeing me, doctor. Sure, I can lie down on the couch.

When I was here last time, it was about my golf game. I still need your help there, but can we talk about work? I'm finding the nine-to-five is my biggest challenge these days.

Okay, I'll start at the beginning. Well, I'm an "active" money manager. That means I try to own the stocks that have the best chance of going up and disregard the rest. If I can't find ones that are undervalued, I stay in cash and keep my powder dry for a better day.

As you know, I love what I do, but it's not just these markets that are getting me down. I'm constantly worrying about beating the banks, other asset managers, the banks, hedge funds, the banks and every full-service broker in the country. My clients and partners want me to beat all of them every quarter, every year, all the time.

The banks? Oh, did I repeat myself? Ha ha. Everywhere I turn in the wealth management industry, they are there.

But Doc, I'm starting to realize that it's not the banks I need to worry about, or Coleman, Sprott and Kanko. It's the "passive" guys. The indexers. The exchange-traded funds sold by Barclays, Claymore and BetaPro that exactly replicate the S&P/TSX composite index, the S&P 500 and other such monsters. The holders of my funds need to do better than they would if they held an ETF in a discount brokerage account. That's how I justify my existence.

But the bloody index is so hard to beat. It has a lower fee than I do. It doesn't change much, so it's efficient from a trading and tax perspective.

It has no style or industry sector constraints and doesn't hold cash that drags down returns when markets are rising. And it isn't affected when a high-profile portfolio manager jumps ship.

But even with these advantages, Doc, we active managers usually outperform the indexers in weak markets like this. That's because we carry at least a little cash, which provides a cushion when markets are going down. And we tend to own less of the sectors that have been on long bull runs and make up a disproportionate amount of the index. We're not momentum players like they are.

From what I can tell, we mostly did beat the indexers over the past couple of years, but not to the degree we normally do. We should have blown them away in this type of market.

Why didn't we? Part of the reason may be that too many of us run high-fee funds that look very similar to the indexes we're trying to beat. But that doesn't totally explain it because even managers that have no idea what the index looks like, such as Brandes, Irwin Michael and Francis Chou, have struggled. I guess it's because the market declines have been so broad-based. Everything has gone down, Doc, even the defensive stocks. And anything with leverage has been eviscerated.

Light at the end of the tunnel?

Um, I know that pointing out other people's problems won't fix my own, but ETFs have their issues, too. They're proliferating as fast as mutual funds did in the '90s and making many of the same mistakes.

The sponsors are confusing people and giving them more opportunities to blow themselves up. Each new fund is more specialized and exposed to a narrower set of risks. I feel like my job gets easier with each new offering.

I say that because funds based on industry sectors or specific themes encourage market timing and sector rotation, which sounds easy in the ads, but in reality is tougher to do than hitting a three iron consistently.

New products tend to be built around strategies that have done well in the recent past, so they encourage investors to chase performance. And some allow people to use leverage to amp up short-term returns - double your exposure, double your fun. I like my clients' chances versus investors who are trying to do this stuff.

And Doc, the ETF's big cost advantage is getting eaten into. No, it's not because my fellow actives are lowering their MERs much, but rather ETF fees are creeping up. Some of the new "Funds of ETFs" aren't much cheaper than a low-cost balanced fund. You can even buy one that has a trailer fee built in. What is it about my industry that compels it to take a good, simple idea like a mutual fund or ETF and turn it into a Hydra that will inevitably confuse and defeat the individual investor?

I guess I'm kind of getting worked up, eh Doc? Well, thanks for listening. Just being able to talk about it makes me feel better already. Oh, and I'll book something for next week on the golf thing.