Index funds are not all created equal. Gordon Pape explains why.
Q – I invest, among other things, in my daughter¹s RESP. She is three. I have decided to make things easy and invest in TD¹s e-series index funds, specifically the Canadian, European, and U.S e-series indices. My money is spread roughly evenly across the three.
My question is, are all such index funds created equal from bank to bank? I have not been pleased with my overall returns the last three years and would consider a switch but if I¹m switching to another company¹s index funds, will the return should be exactly the same, less fees? They all follow the same index, is that correct?
In other words, do all stock market index funds show basically the same returns? Thank you and keep up the good work! – Aaron
A – The basic answer to your question is yes. All index funds that track the same index should generate approximately the same result before fees and expenses.
Having said that, not all index funds are created equal, even those that may appear to track the same basic index. For example, some use an equal weighting process, others use the same ratios as the indexes themselves, some select the top dividend payers from an index, some focus on low volatility stocks, while some use a variation of the main index. With all these variants, you can end up comparing apples to oranges.
The TD Canadian Index Fund (e-units) posted a three-year average annual return of 3.55% to the end of April. It tracks the basic S&P/TSX Composite Total Return Index.
You would have done better with the iShares Canadian Fundamental Index ETF (TSX: CRQ), which is based on a different Canadian Index. However, it aims to replicate the performance of the FTSE RAFI Canada Index, net of expenses. So it invests in Canadian stocks but not in the S&P/TSX Composite. The three-year average annual return is 5.32%.
Among other Canadian index funds that did better than your TD fund were the BMO Low Volatility Canadian Equity ETF (gain of 5.81%) and the iShares Jantzi Social Index ETF (5.31%). The latter invests only in socially responsible stocks.
TD’s U.S. Index Fund e-units, which tracks the S&P 500, posted a three-year average annual return of 12.37% to June 30. That was quite good. The BMO S&P 500 Index ETF was only a hair better at 12.40%. You could have received a better return by using a Nasdaq ETF, but with more risk. U.S. funds based on the Dow Jones Industrial Average also tended to do better than those that tracked the S&P 500. The e-units of the TD Dow Jones Industrial Average Index Fund averaged a 14.99% return over the past three years.
As for Europe, the TD European Index Fund you are using has the best three-year record among index funds in that category, at 5.99%. – G.P.