“The house always wins” is a common expression describing the statistical advantage a casino has in the long run. Despite the certainty of the odds being mathematically stacked against the gambler, human psychology finds a way to frame a positive outcome in their own favour. The absence of clocks or windows sure helps keep gamblers at their tables – whether they are chasing the big win or scrambling to recoup losses. Free drinks help too, as does the occasional “comp” of a free hotel suite or steak dinner to soften the blow of an unlucky streak at the tables.

If you were to risk your hard earned money in a casino, then it may be useful to know the probability of winning in each game. The approximate probabilities are listed here.

  • Slot Machines – 47% player versus 53% casino
  • Roulette (betting black or red) – 47.4% player versus 52.6% casino
  • Blackjack, Craps and Baccarat – about 49% player versus 51% casino

Overall, the probabilities are worse than a simple coin toss – and that is more than enough to keep the casino’s in business.

In the mutual fund industry, investors should be aware that the odds of their mutual funds beating the index are far worse. The “Active Management” strategy, whereby mutual fund managers use stock selection to try to outperform the benchmark index, consistently fails over time. In fact, over a 10 year period, over 87% of all domestic US equity mutual funds have underperformed the benchmark index (net of fees to June 30, 2016). In Canada, the statistics are only marginally better – over a 5 year period, 65.5% of all Canadian equity mutual funds underperformed the S&P/TSX Composite Index (net of fees to December 31, 2015).

I would recommend that all investors take a moment and review the comprehensive data produced by S&P Dow Jones Indices in their S&P Indices versus Active (“SPIVA”) site. Overwhelmingly, the evidence supports that fact that across geographies, styles (small cap, value, growth, large cap, etc.), and asset classes (equities or fixed income) – active managers fails to outperform the relative benchmark.

Combine under-performance with high fees and its clear to see that the house isn’t winning anymore. Increasingly, investors are adopting a “Passive Management” strategy of investing in low cost ETF’s, or index funds, to execute their investment strategies. This shift was well documented by Morningstar in a report that detailed that active equity funds globally registered outflows of $89.3 billion in 2015, while inflows for their passive equivalents soared to $398.4 billion.

Banks, Insurance, and Mutual Fund companies have long benefited from keeping the odds stacked in their favour. The business model for active managers is at risk as investors shift their assets to passive investments. Canadians lag their American peers in adopting passive ETF strategies, but this momentum will likely shift as awareness and evidence continues to grow around this subject.

 

Please contact me if you would like to learn more about how passive ETF strategies can be implemented within a portfolio to reduce risk and enhance returns.

Share This