Active Versus Passive for the US and the Canadian Markets

Active Versus Passive for the US and the Canadian Markets

February 7, 2017 Behavioral Finance, Active and Passive Investing, ETF Investing
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(Last Updated On: February 7, 2017)

We all hear about the massive move away from active to passive in the US market. We also hear arguments that passive may eat the world and that active management is a zero sum game (seems like a reasonable hypothesis, but I’m not so sure).

Here is a figure from a recent CS report that highlights the US activity and the clear move away from active and into passive:

us passive and active
Source: CS, “Looking for Easy Games”

All of this chatter seems viable from a US-based perspective.

Interestingly enough, you don’t have to look that far to see a completely different narrative playing out. When we look North to Canada and we see an entirely different game playing out:

Thanks to Ben Johnson for highlighting this research report!
Source: Morningstar. Thanks to Ben Johnson for highlighting this research report and thanks to Art Johnson for bringing this to our attention!

The Canadian market highlights a completely different story — a move towards more active and a move away from the tiny amount of passive already in place.

Wild!

Here is a comparison chart of the move to passive between the US and Canadian markets:

Source: Morningstar
Source: Morningstar

What is going on?

The real answer is “who knows,” but the Morningstar Canadian crew has an answer:

Big banks, incentives, and backward self-regulation are to blame.

Incentives certainly play a role. Perhaps recent past performance also plays role? Maybe even culture?

My takeaway is that the narrative claiming that passive is going to destroy and/or eat the financial world is too simplistic. There are a lot of mechanisms at work in the financial marketplace and their interaction effects are extremely hard to predict. I don’t have the answers and I can’t predict the future, but it will sure be fun to see how it all plays out!


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About the Author

Wesley R. Gray, Ph.D.

After serving as a Captain in the United States Marine Corps, Dr. Gray earned a PhD, and worked as a finance professor at Drexel University. Dr. Gray’s interest in bridging the research gap between academia and industry led him to found Alpha Architect, an asset management that delivers affordable active exposures for tax-sensitive investors. Dr. Gray has published four books and a number of academic articles. Wes is a regular contributor to multiple industry outlets, to include the following: Wall Street Journal, Forbes, ETF.com, and the CFA Institute. Dr. Gray earned an MBA and a PhD in finance from the University of Chicago and graduated magna cum laude with a BS from The Wharton School of the University of Pennsylvania.


  • Gregory Szucs

    In Canada we have among the highest mutual fund MERs in the world. 2-2.5% per year for domestic and US equity, 2.5-3% per year for international equity. Canadian financial institutions therefore have a huge incentive to push actively managed products. I once had a meeting with a financial adviser at a Canadian bank to discuss investment options. She refused to admit they sell index mutual funds until I physically turned the page of her fund catalog for her to the index funds section.

  • that’s pretty insane! Thanks for sharing your story. I think US-based investors/advisors find all of this perplexing given what is going on in the states…fascinating!!!

  • Hannibal Smith

    Canadians have way more trust in “authority” than Americans do, so it’s definitely cultural. They expect only goodness from their fellow citizens, eh?

  • sounds good to me, eh.

  • Digitking

    That Morningstar report was debunked a long time ago…, the MER is almost the same between Canada and the US when you factor in the broker trailing commission (which is not counted in the US). The actual difference was 0.02%.

    From the Canadian perspective, the big fund providers (especially banks) have been pretty aggressive in cutting fees (especially for the investors) which has helped. A lot of the fee based premium-tier MERs are in the 50-60bps range now (plus fee based/discretionary fee). Also I think because of the implosion of commodities, energy and Valeant, rightly or wrongly active managers have made the case whereby they might not be able to beat the markets but can be better risk managers… Only time will tell

    Edit: I didn’t think but there might be another reason, technically you only need to hold 51% CDN equities to be classified as a Canadian equity fund. However most funds have a fairly significant (20-35%) weighting to US stocks (a little to INT’L). Considering the last couple years with the big decline in the CAD vs USD plus the significant out-performance of the S&P 500 has allowed many “Canadian” equity funds to either match or beat their benchmarks which might explain a big part of the reason passive investing hasn’t taken off yet.

  • Patty O’furniture

    When Poloz & Trudeau took over in Canada, prudent investors got their funds out of Canada (or at least out of Canadian dollars). Their stated goal was to weaken the Canadian dollar. Their intended effect was to increase CURRENT Canadian revenues. While this would make Canadian companies (and by extension, Canadian equities) look good as well as improve the CURRENT income of Canadian workers (CURRENTLY working), it effectively screwed savers/investors by debasing their investments. They didn’t even need to devalue the Canadian currency – simply hinting that they would do so sent the CAD tumbling.

    In the past – I can’t speak for the last 3-4 years as I yanked my $ out of Canada when the duo above entered the picture – Canadian law permitted structures that effectively converted earned interest and dividends (taxed at ordinary income rates) into long-term capital gains. These vehicles were often complex, requiring active management. Changes in the US/Canadian tax treaties and the US treatment of foreign investments changed the willingness of Canadian firms to offer these products, especially to US citizens.

    Canadian fund MERs have come down largely in response to investment dollars (especially foreign $) exiting Canada.