Active vs Passive Management In Investing

In this episode of Bare With Us, we dive deep into one of the most debated topics in investing: passive vs. active strategies. We begin by breaking down what an index actually is, how different indices are constructed, and why not all indices are created equal.

From there, we explore some of the lesser-known mechanics behind passive investing—what’s happening behind the scenes that most investors never see. Finn shares his perspective as an active Portfolio Manager, explaining how active managers aim to add value, especially during periods of market stress. Mike and Scott weigh in on the merits of both approaches, highlighting how financial advisors can thoughtfully use either strategy to serve different client needs.

Key takeaways from this episode:

• Index construction matters—and it’s not always as passive as it seems.
• Active market participants can add meaningful value, particularly in volatile or complex markets.
• There’s no one-size-fits-all solution: the right strategy depends on your goals, behavior, and financial plan.
• Investor discipline and behavior are often more important than the strategy itself.

Whether you're a DIY investor or working with an advisor, this episode will help you think more critically about how your investments are managed—and why that matters.

What is Bare With Us?

We welcome you to “Bare With Us,” the podcast where we Bare Out the latest economic and financial questions that matter to you. Mike Robinson, a Chartered Investment Manager (CIM) from Calgary, Scott Richardson, a Certified Financial Planner (CFP) from Edmonton, and Finn McKay, a Chartered Financial Analyst (CFA) from Winnipeg, engage in an unstructured discussion, bringing you a wealth of knowledge and a diverse experience from the world of finance.

Each episode features an unstructured, unscripted and entertaining discussion where we pursue ideas and concepts as they arise naturally through our conversation. We tackle a broad range of timely topics, from economic or market trends and financial planning strategies.

Whether you’re one of our valued clients, or someone new to our insights, our goal is to provide you with valuable information, from diverse perspectives, that can help you navigate the complex world of finance.

We are experts in our field, but we are new to podcasting, so we invite you to Bare With Us, while we learn, grow and share! Please feel free to reach out to us with any feedback, to suggest any topics, or to learn how to work with us. You don’t have to, but you can!

Finn: 00:00

On this episode of Bear With Us.

Scott: 00:02

I I think there's a lot of stuff going on in the passive world that people don't understand. I think it's but it doesn't mean that it's wrong. And and if it's something that you're interested in and you like and it and it fits with your financial goals and plan, then then keep doing it. But it doesn't mean that it's what your neighbor has to do as well.

Finn: 00:25

Well, mean, yeah, like like knowing what you own is a really critical part of of investing and you can't really do that with an index.

Mike: 00:31

For a reminder for people out there, this is intended to be sort of a conversation that we would have with all of our clients or people that we interact with on a daily basis. Like, this isn't meant to be a lecture. No. It's meant to be a discussion.

Scott: 00:54

Five? Well, because four was Alright. Two episodes. Yeah. Because those And it goes in as four and

Mike: 01:02

five. I

Scott: 01:03

mean, it's based on that.

Finn: 01:04

I mean, it's kind of it's kind of fun to say this is episode five or six. We're not really sure.

Mike: 01:09

Yeah. It doesn't much matter. Yeah.

Finn: 01:12

This is the next episode.

Scott: 01:15

Yeah. Okay. So it's episode five or six. We don't really know because one of them was two parts. I don't know if you count that One episode

Mike: 01:24

I counted as one, but it doesn't matter.

Scott: 01:27

I kinda counted it as two, but that's okay.

Finn: 01:30

We have an episode discussing whether or not that was two episodes.

Mike: 01:33

And and we launched episode one was actually episode three.

Scott: 01:38

That's that Star Wars piece again.

Mike: 01:40

Star Wars. Yeah. Yeah.

Scott: 01:43

Okay. Welcome everybody. Thank you for joining us for episode five or six of the Bear With Us podcast. My name is Scott Richardson. As usual, I am joined by Mike Robinson and Finn McKay.

Scott: 01:58

And today, we are going to tackle active versus passive management, in investing. Active versus passive. Yeah. I I think I I get way more questions about, ETFs versus funds. So I think it's a good thing to to tackle, especially if we're talking about this podcast kind of going out to people who some younger people or or clients of ours.

Scott: 02:27

Kids. Yeah. Because I have tons of clients coming to me with their kids saying they should be in ETFs.

Finn: 02:34

Right. Well, and and ETFs are like a like a fund structure format, not necessarily active versus passive. You can have that an an actively managed.

Mike: 02:42

But it it used to be.

Finn: 02:43

Right. Exactly. It used to It it it out of, index funds. Index funds. Yeah.

Finn: 02:49

Yeah.

Mike: 02:49

The structure the structure is largely largely irrelevant, like whether it's an ETF or a mutual fund open other than fees. But even an index mutual fund is is low fee Mhmm. Because there's no active decisions being made. Mhmm. But originally, they were like, ETFs were just low cost index mutual funds.

Mike: 03:14

But they made them ETFs, like, on the exchange instead of, like, through a mutual fund dealer.

Finn: 03:21

Yeah. And I guess I guess the the the other main difference between, like, a mutual fund and an ETF is that, like, it's how you how you buy it because you're buying, like, a security that is actively trading at the moment when you buy an ETF, which means that it can become mispriced, throughout the day.

Mike: 03:37

It's

Finn: 03:37

possible. It's possible. It doesn't it doesn't a lot of people like to say that that happens all the time, but it it it's it depending on the ETF, it's pretty rare. And so, you know, you can you can buy it at, like, 11:00 at a different price than you would have bought it at at, like, 10AM.

Mike: 03:52

Well, for sure.

Finn: 03:52

But And then for a mutual

Mike: 03:54

doesn't mean it's mispriced, though.

Finn: 03:55

No. No. No. Of course not. Of course not.

Finn: 03:57

That's just the active trading of the value of the securities underneath the ETF. But for a mutual fund, you buy it and it's priced once a day and then you get that price.

Scott: 04:04

Yeah. Well, Mike, we were talking, like, earlier offline about kind of what the original design was of a passive fund. And I think you should start by talking

Mike: 04:19

about that that If you talk index fund and index trade ETF, this is the the thing that I'm well, I can start with it, but it touches on one of the potential pitfalls of where ETFs are today.

Scott: 04:34

Yeah. But I think you gotta start with it so that you'd ever like, that we can understand what a a passive fund

Mike: 04:40

Passive versus active. Yeah. This is And and where it came from. Shouldn't necessarily be an ETF versus

Finn: 04:46

Yeah.

Mike: 04:46

Yeah. Non ETF. Yeah. It's active versus passive. Yes.

Mike: 04:51

And so when I came up through the ranks and did my degree in finance and entered the industry, like, an index fund, regardless of its structure, is meant to be a replication of all the active decisions that are being made. Like, you look at it and say, well, most active active managers or or active participants in the market don't beat the index. So the theory was then that we'll just buy the index, and you are essentially getting the aggregate decisions of all the active participants.

Scott: 05:27

Yeah. Because when passive didn't exist, the market is all active.

Mike: 05:32

The market was all active. Yeah. So let's just get no one some people do better some years, some people do better other years, and and it flips around. So you get the aggregate decisions of all the active participants. And that's fine.

Mike: 05:47

I understand that theory, and and that's why they exist. There's nothing wrong with that theory. But we are at a point now where passive has become so large that on certain trading days, if not many trading days, particularly in The US, this is more of a US issue, S and P 500, but there are days, and growing, where the the participation in the market is greater from passive than it is from active. So, therefore, you are not getting what you were originally intended to get. You're supposed to get the aggregate decisions of all the active managers, but if the majority of the trades are not being done by active managers, you are not getting that anymore.

Mike: 06:32

And I think that starts to break down the whole passive system.

Finn: 06:38

Well, and I think, like, just to kinda take a step back, like, kinda defining active and defining passive a

Mike: 06:44

little bit. Yeah. That's a good idea because, maybe, not everyone might not necessarily

Finn: 06:47

know exactly what that means and

Mike: 06:49

Yeah.

Finn: 06:49

Sort of how how these indexes are also built because every index has a different, like, body that is responsible for it and the methods under which they actually build these indexes, what goes in the way you actually own if you own indexes might be different. So, you know, to kind of just top level define active management, active management is where you have a team of people who are doing research on businesses and there's a or also, I mean, there's a lot of different ways you can do active management too. But basically, you have someone who's a decision maker saying, these are the securities that I want to own because I believe that they have a high return potential, especially from, like, a risk adjusted basis, which is another thing people don't really consider when they think about active versus passive is the sort of the risk underlying those two different approaches. So you have somebody who's actively making these decisions. This is what I want to own today because I think that it has good risk adjusted return into the future.

Finn: 07:44

And then the passive side or the index investing side, these are sort of two things that are usually used interchangeably. Yeah. Yeah. Is is really where you have a body that has decided that you want to replicate a certain market essentially for the purposes of either a benchmarking perspective for active managers or from now more so from an investing perspective. And so there's a huge variety of different indexes of different ETFs, which are the conduit for which people invest in these indexes that do this sort of passively managed, meaning that there isn't really active decision making being made to decide what actually goes into these indexes.

Finn: 08:25

And it actually it's it's sort of funny because people talk about how, you know, they use the term passive, but some of these aren't really that passive. Like, you know, the Dow Jones index is famously not really passive at all because there's actually a committee that's deciding what goes into that. Right. Quote unquote index. Although, I do think that people who quote the Dow Jones, you know, it's sort of like, you know, they're it's a price based index, so it's it's you know, the way that it's built doesn't really make a lot of sense in in the modern day at least.

Finn: 08:54

But something like the S and P five hundred, like, lot of people say, oh, well, it's just the largest market cap companies in the S and P five or sorry, in The US. That isn't the case. It's a discretionary based index, so they actually have a committee, the S and P Dow Jones indices committee, and they have, like, a strict methodology on what kind of businesses make it into there and sort of some rules around, you know, different sector allocations, you know, what types of businesses are in there. But they actually are making active decisions and saying, you know, these are the businesses that are gonna go in. These are businesses that are gonna come out.

Finn: 09:26

And the idea is that they wanna own the 500, you know, largest leading businesses in in The US.

Mike: 09:33

On the exchange?

Finn: 09:34

That's available. Yeah. On the exchange.

Mike: 09:36

Yeah. Yeah.

Finn: 09:37

And so, you know, and it and it's and and that's for the S and P 500 whereas there's a whole bunch of other different indexes out there like the MSCI World, which is sort of a more global approach to indexing. And that that's a more rules based systematic structure, than the S and P 500, which has more discretion. But there's, like, literally thousands of different types of indexes. Right. There's also even custom indexes that portfolio managers request that are customly built by MSCI for, like, a specific strategy that they wanna benchmark against to show that they're performing well relative to their investable universe.

Mike: 10:16

I think it's also worth backing up a step further. Because my experience has been that people will say, well, the market did this or the market did that today. And people don't really fully understand what that means when they say that. When people say the market was up today, what they really mean is the index Right. Was up today.

Mike: 10:39

So for people who don't know, these indices that we're talking about is not the market. They are a subset of the market. So as you said, like, the S and P 500 is a is the largest 500 companies on the New York Stock Exchange.

Scott: 10:58

TSX in Canada.

Mike: 10:59

And the TSX in Canada, I don't know what the number is today, but call it 250 of the largest traded companies on the Toronto Stock Exchange. Yes. So it's not the market, but it is a fair representation of the market, and that's why people use it as benchmarks or to see how you're doing or what or what you're doing.

Finn: 11:21

And something that's a bit interesting is that increasingly specific to the S and P 500 is historically, you know, the top 10 companies in the S and P 500, you know, might have been a, you know, 10 or 15% weight in the actual S and P 500. And as the entire world has kind of moved towards this, like, mega cap tech story that has really played out very well in The US, now it's, like, 30 to 40% of the S and P 500 is in 10 companies. So it's increasingly not actually as representative

Mike: 11:52

It is not a representation of the market.

Finn: 11:55

Yeah. And so yeah. So when you like, there's 70,000 publicly traded companies globally and, you know, the 500 in in the S and P 500, you know, that's not necessarily a good representation of of the market. And it's funny when, yeah, when people talk about the market, and I'm, know, for those Using air quotes air quotes when I'm talking about it. Yeah.

Finn: 12:16

So, you know, if you if you have 70,000 companies that are publicly traded globally, in any given moment, a whole bunch of them are up, a whole bunch of them are down, a bunch of them are flat. And so when people talk about The US market, they typically refer to the S and P 500, but there's also, like, the 100. There's also the Russell 2,000, which is, you know, a larger subset of companies in The US. And and people talk about the S and P 500 because the S and P 500 has been such a dominant index for the last, call it, fifteen years. But also, like, you know, people forget that in in 02/2011, 02/2012, the S and P 500 was negative for the last fifteen years.

Finn: 13:00

And when they refer to the market, I don't know. Maybe were they referring to I mean, you guys would have would know better better than me. Like, were they were they thinking about the S and P 500 when you refer to the market in that period, or were they was it more broad in terms of, like, the TSX and the MSCI world?

Mike: 13:14

I would say that when when clients are asking, they're talking about a bit of a blend between the TSX and the S and P five hundred. But really what they're talking about is what they just hear in the media. Yeah. Like, the market did this. The market did that.

Mike: 13:32

Interesting too, like, the S and P five hundred has been the dominant index in the last fifteen years or so, as you say. It used to be the Dow Jones. The Dow Jones Industrial Average Yeah. Is an index on the New York Stock Exchange. And also, people don't fully understand that the NASDAQ is a separate stock exchange

Finn: 13:57

Mhmm.

Mike: 13:58

Than the New York Stock Exchange or the Toronto Stock Exchange. And those indices are representations of those exchanges.

Finn: 14:06

Well, the S and P five hundred has Nasdaq companies in it.

Mike: 14:09

Yes. Mhmm. Yeah. Yeah. The Dow Jones doesn't.

Mike: 14:14

Nasdaq companies? I don't think so.

Finn: 14:17

Is Salesforce in there? Remember. But yeah. Yeah. And but No.

Finn: 14:22

You're right. Like like, these are these are all different beasts with different numbers of companies that and and they also are constructed differently. Right? So the

Mike: 14:30

Well, right. So edit this out if we can't answer this well, but they are constructed differently, particularly the Dow Jones versus the S and P five hundred are wildly different.

Finn: 14:39

Oh, they're absurd. Yeah. The the Dow Jones makes very little sense, to be honest.

Mike: 14:43

So can you can you explain that?

Finn: 14:45

Well, so so the S and P five hundred is a market cap float adjusted market cap weighted index. That's a lot of words. Float adjusted and this is a Can you explain that? Yeah. Yeah.

Finn: 14:56

Yeah. Can you explain that? Here's something Like it sounded

Scott: 14:58

like you just ordered at Starbucks.

Mike: 15:02

You made you made it worse.

Finn: 15:03

Yeah. Yeah. I love the tall float adjusted market weighted index, please. Thank you. No whip.

Finn: 15:09

Yeah. Yeah. Please no whip on my index. That makes it a little too heavy for me. Yeah.

Finn: 15:17

So and what that means is and and there's a bit of history behind that too, the the float adjusted part, but I'll start with the market cap weighted. Basically, the amount of money if you buy an S and P 500 index, the amount of money that is allocated within the dollars that you put let's say you put a $100 in. Right? And so, you know, today, I think Nvidia, for example, is 8% of the S and P 500 index. And that's not just some random percentage.

Finn: 15:43

There's 500 companies. If it was equal weight, it would be obviously a lot lower. It's that the market value of Nvidia as a percentage of the market value of all of the companies in the index is 8%, if you take the float out, and which I'll talk about more in a moment. So all of the companies go through and it's like, this is the market value of that company, so that's the weight that it gets in that index. Does that make sense?

Finn: 16:05

Yeah. Yeah. Okay. Absolutely. Okay.

Finn: 16:06

So then then then the float adjusted part, I I believe, and correct me if I'm wrong, I believe that that actually became more like, using a float adjusted index became more popular coming out of the tech bubble because something that happened going into the tech bubble was that you would you would IPO so in the tech bubble, everyone was going crazy for these tech stocks and you'd have all these companies that had no revenues, no profits, it'd just be like And they would go public. And they would go public because you could raise astronomical amounts of money and if you were if you started a new company, like, you know, what is it? Like, pets.com was a famous one or, I don't know, whatever. There's a whole bunch of different small companies that came out of, the tech bubble that inevitably disappeared. But they they would IPO.

Finn: 16:52

They'd raise a ton of money. And how you one of the one of the tricks that people would do is they would they would they would IPO a very small percentage of the actual entire shares outstanding for the company. So if you had a a 100 shares outstanding, you would IPO 10% of that. And so only 10% of it would actually be owned by public public investors, like stock,

Mike: 17:17

you know On the exchange.

Finn: 17:18

On the exchange. And the other 90% might be held by management or by the venture capital Companies. Or the founders, whatever it was, you know, whatever owners ownership structure they had. And so what would happen is you would you would have only 10% available for people to buy, but the index, because it wasn't float adjusted float meaning the percentage that is available to buy for publicly traded investors. Because you only have 10% of that available, there would be, like, this aggressive buying into this incredibly low liquidity piece of your business, and it would shoot your stock up like crazy.

Finn: 17:53

And it artificially created this well, I mean, it it was lot of people blame that for creating the tech bubble essentially.

Scott: 18:00

Fin, are you basically saying, like, they were putting their the value of the company was determining how much

Finn: 18:09

Yes.

Scott: 18:09

They so Yes. But they never adjusted for the fact that there was only 10% of the available.

Finn: 18:14

So Yes. That's great. Yeah.

Scott: 18:15

Okay. Yeah. So that makes more sense.

Mike: 18:18

I did not know that.

Finn: 18:19

Yeah. So if your company was worth a $100,000,000, you would IPO 10,000,000, and the index would be trying to buy that $100,000,000 sleeve worth in its index. But it it it It couldn't. It couldn't really.

Scott: 18:32

Because there's only 10.

Finn: 18:33

Yeah. Because there's only 10. Yeah. Exactly. Okay.

Finn: 18:34

A very simplified version of how how that looks. And, so now that's why they do float adjusted because now it's like, okay. Well, you only IPO 10. 10 is the only amount available. We will only be trying to fit that as the value in the index.

Scott: 18:46

Okay. That makes total Yeah. Way more sense. Yeah. Thanks, Finn.

Finn: 18:50

Yeah. No. That's good. So so yeah. So that's why they use a float adjusted, so that's why it's a float adjusted market cap weighted index.

Finn: 18:59

Whereas for the Dow Jones, it is a price weighted index, which means that the actual price of the stock, I believe, is part of the methodology for determining the weight in the index. And I think that they do some adjustments now for that because of the fact that the stock price has very little bearing on the actual value of the business in terms of the fact that there's two components to the total value of the business. There's the stock price and the shares outstanding. The market value and, well, this is this is a a common misconception. Actually, we were talking about this yesterday that, you know, I have friends who think that the value of a company is based on the the stock price, and that's it.

Finn: 19:38

And they say, oh, well, the stock price of this company is 300 and this other one is 200, so the one that's 300 is expensive. But that's not at all how it works. You have to consider the total market value of the company, which includes, you know, the share price, the dollars you pay per share, times the amount of shares that are outstanding. That actually determines the total value of the business. Market cap.

Finn: 19:56

Market cap. Exactly. And so when you when you focus only on the price of the stock, it really is a kind of a twisted way to construct an index.

Mike: 20:05

Right.

Scott: 20:05

That's cool, Fin. So I want to pick your brain kind of leading to the the decisions in in active versus passive. Because now that you've explained kind of the market cap piece and float weighted

Finn: 20:18

Yeah.

Scott: 20:20

Because I think people don't really understand when they're buying, let's say, an index fund or a or a a passive investment that when their money is going in, what is it going in to buy versus you're an active manager, Fin. When money's coming into you, you'll make a different decision to buy. And and when you just explained that 10 companies in the S and P make up 40% of that's a high weighting. That's a high exposure. So I think it'd be good to just do a bit of an explanation of of what happens.

Scott: 20:59

Because with passive investment, my understanding is basically what it does is you give me money, I buy. If you need money, I sell. But it's not making any decisions on how it's allocating that. It's just if this company is 8%, I buy 8% of that and 8% of this. So it's not making And

Mike: 21:23

then rebalance

Scott: 21:23

on daily rebalance on a daily basis. And and if they're and and we'll get into this later, I think, because we have to talk about flows.

Mike: 21:30

Mhmm.

Scott: 21:31

But so can you explain, like, if you if you're an investor and you wanna put a $100 into a a passive investment or an active investment, what's that investment decision gonna look like and how do they differ?

Finn: 21:45

Yeah. That that's a great question. So, for if it's a passive investment, it it yeah. Like like you said, it's exactly you know, they they basically get allocated to exactly what the weights are at that time. There's really no decision making in terms of the value construct of different companies.

Finn: 22:03

And so that's oh, sorry. Yeah. Thank you. Yeah. So there's there's really no difference in terms of backing up there.

Finn: 22:13

When you put when you put a $100 into an index fund, it is essentially buying exactly the weights of the index at that time and that there's no active decision around the prospective return of those individual companies. Whereas, if you do a actively managed fund, you basically when you put the money into the into a mutual fund, it will hit the cash account for the mutual fund, then the active manager will make decisions to allocate that money according to where they see the prospective returns.

Scott: 22:43

Okay. And so Yeah. As an active manager, if if like, given some of the numbers that you just said, would you ever be able to allocate money the same way that, let's say, a passive investment in the S and P where you have all of your money exposed to the to 10 like, you have that high awaiting in one company?

Finn: 23:09

Yeah. So I I believe that there's rules in Canada that prohibit, and I I I think that index funds some index funds do have rules around individual company weights. But I I believe the the rules for Canada is that you can't have more than 10% of the book value of a fund to be in one individual security.

Mike: 23:28

Well, that's the rule in a prospectus based mutual fund. Yes. There's nothing to prevent an individual investor from being a 100% Yeah. In one stock if they want to. But on a prospectus based mutual fund, which is what you're getting at, like active versus Active versus passive.

Mike: 23:42

Passive. That that's the Canadian mutual fund rule. Yeah. Hedge funds offering memorandum funds could break that.

Scott: 23:50

Yep. Yeah. Yep. But to me, that's one of those big differentiators of you may be buying something that you don't know that you're a little bit more risky than what you thought you were.

Mike: 24:03

Think that's a last ten years to fifteen years kind of thing that has evolved, and I'm not sure it's going away anytime soon, is that, again, going back to my earliest comments, like you're supposed to be getting a representation of the broad market, sort of an aggregate of all the active decisions. But at least at the moment and for the last ten to fifteen years, that is not what you're getting. You are getting a heavily concentrated investment into and what are you said the percentage is. You know, 40% are in 38, yeah. 8% are in a small number of companies.

Finn: 24:43

Yeah, and that's, that is a recent change. Like, you look at index construction, and there isn't very much good data going very far back on the percentage weights of individual companies in the index going back more than forty years ago. But if you look over the last forty years, this is we are at, like, a point where it is a bit, like, a lot more concentrated than it ever really has Yeah. Been. The thing that is also a bit interesting in this respect is that generally the largest companies in an index have been historically the worst places to invest over the last, like, you know, forty, fifty years or whatever.

Mike: 25:20

Say that again?

Finn: 25:21

Generally, the largest companies in an index have been the worst places

Mike: 25:25

By market cap.

Finn: 25:25

Yeah. By market cap have been the worst places to invest. And there's there's like if you think about kind of like regular laws of economics, like, once you get too too big, how can you continue to throw off the amount of growth that you need to continue to become a bigger business? Right? So, you know, in the nineteen thirties, a huge portion of the index was railroads.

Scott: 25:45

Right? Yes.

Finn: 25:46

And, you know, for a railroad to be to go from being I mean, this is, like, call it inflation adjusted revenue of, a $100,000,000,000 to for it to grow another 40%. For a railroad to grow 40% on a $100,000,000,000 is kind of an absurd proposition.

Mike: 26:01

Right? Impossible.

Finn: 26:01

It's virtually impossible. They have to build so much more railroad tracks. They have get all these permits. They have to then also get all the volume on and, know, assume that there's going to be all this volume. But there has been a a very big change in the world in that a lot of it has become more digital.

Finn: 26:17

So it's a lot easier for a large company to grow. Like, you know, a company like Alphabet can add, you know, call it $5,060,000,000,000 dollars to their $300,000,000,000 revenue in a year, and that's that's a good year for them. But that's and that's, like, not an absurd proposition. And the same thing goes with Microsoft and Amazon and all these other businesses that have become more digital. The economics of their businesses have just changed that much.

Finn: 26:43

And so that's one of the reasons why the index has done well the last fifteen years is because, a lot of the rules around that prevent the largest businesses from doing well have changed.

Scott: 26:56

So with that in mind, if you're talking about the largest businesses and to go back to my question before, like in a passive fund or an index fund, when it's getting money and it needs to go buy and say it's that largest company, well, it's buying that and like, it's not making a decision at what price it's buying it.

Finn: 27:19

Yes. Yeah.

Scott: 27:20

Is So it will pay any price. Like, the the price is the next price.

Finn: 27:25

It Whereas will always buy at a higher price.

Scott: 27:27

Yeah. As long as that especially if, like you mentioned, the flows, the the the money that's going into passive that it's over 50% of the decisions in a day can be made with a passive investment. So if all of those are making a decision to buy and they're making absolutely zero decision on what price, then inherently that price is just going to keep going up.

Finn: 27:53

Yeah. It's like a self fulfilling.

Scott: 27:54

It's like a self yeah.

Finn: 27:55

Yeah.

Scott: 27:56

And so whereas for you, Finn, when you get a dollar coming in, you don't you have discretion over what you buy at what price. That's that's to me, that seems like a big differentiator between, like, active and passive management on the inside of it.

Finn: 28:13

Yeah. Well and and the other side, like, if we're talking about differentiators between active and passive, like, I can do things like during the sell off, which recently happened in April, which was where, you know, indiscriminate selling was happening across the board, and we're seeing a whole bunch of different businesses see their share price decline precipitously even though nothing really seems to be happening to those specific businesses. And we can now make changes in the portfolio to take advantage of that, which is something that a passive index would never be able to do.

Mike: 28:42

They would in fact do the opposite.

Finn: 28:44

Yes. Well, exactly. Yeah. That's a good point. Like, as as you put more money into the index and as the index continues to grow, like, we talk about how in NVIDIA is now the largest weight in the S and P 500 at, I think, like, 8% or something like that.

Finn: 28:57

So every time somebody puts a $100 in, NVIDIA is getting the highest allocation, which is naturally pushing the share price higher. And then that will work in reverse as well.

Mike: 29:08

Well, right. So that's the this is one of the concerns I have about passive. And today, I don't, you know, this clearly isn't a concern, but as we look at it in the future you know, because one argument could be made, Scott, that you're right. You know, as money comes in and these passive firms are so large, there's a bit of a self fulfilling prophecy. In that in the more like, you know, this doesn't actually work this way.

Mike: 29:35

But in the morning, they arrive at the office and NVIDIA has gone up by 4% in a day. They turn around and and buy more. And they're so large now that that buying activity in itself pushes the share price up. But the the flows are positive because people are putting more and more in and because we're at a point where particularly employer sponsored retirement plans are moving to passive. And so as you buy, it pushes the share price up.

Mike: 30:15

But there is going to be a point where people are all retiring, and it's gonna push it the other way. Mhmm. And so instead of Navidea being up 4% a day, it's gonna be down 4% in a day. And the index is gonna say, well, we have to sell. Even if you as an active manager think that it's a good price or a good purchase, it doesn't matter.

Mike: 30:41

It's going to be a self fulfilling prophecy on the downside.

Scott: 30:45

Yeah. So, Mike, just to clarify what you said with flows. Flows mean there is more money going into an investment than there is coming out of it. Right. So it's it's always positive with the amount of money that it has to allocate.

Mike: 30:59

Right. Yeah. This is important in terms of demographics as well. So if you think people would say, well, the baby boomers are all retired or retiring now. Yeah.

Mike: 31:09

But they didn't participate in the market the way that generation x or and beyond does. So, like, my father, who's the front end of baby boomers, like, he he didn't own any of the stuff. He had a defined benefit pension plan. Nobody has that anymore, and now we're talking Canada. But it's a similar concept in The US.

Mike: 31:31

Now you have a lot of people in in The US and in Canada who are participating in the market through passive investing, through their employer sponsored programs. When they start retiring, and gen x is a is a small part of the demographics, but gen y is as big in terms of number of people as the baby boomers. And so when gen y starts to retire, the flows are gonna turn negative because employer sponsored plans, they're all retired, and the money's gonna start coming out. And there's no decision on whether selling that stock is a good idea or not. It's just sell.

Mike: 32:16

And it hasn't been a problem today, a, because passive passive was was a very small segment of the market ten, twenty, thirty years ago. And even if it wasn't, like baby boomers didn't participate in that way. Yeah. And now we all do. Everyone participates that way.

Mike: 32:36

And it's a concern. I'm not I'm not saying it's gonna happen. I'm saying it's a concern that is out there.

Scott: 32:42

Mike, I think you're right that right now, a lot of the baby boomers or anyone that's older, 60, 65

Mike: 32:51

Retired. Or

Scott: 32:52

leading into retirement.

Mike: 32:53

Leading in.

Scott: 32:54

Yeah. Like, they are the ones who participated heaviest into active managed mutual funds. You know, you think of the nineties Yeah. Eighties, like everyone investing then, they were all active. Everyone was going into actively managed mutual funds.

Scott: 33:12

And so now what's happening is as they start to retire, they're selling off actively managed investments. And the younger generations are all buying passive

Mike: 33:24

That's right.

Scott: 33:24

Index funds. That's right. And so what happens is we're seeing you know, we we see it in the news all the all the time and or at least in the news that we read that, you know, active managed mutual funds are in net redemptions. There's more withdrawals than there is money going into them. And so that causes a problem because like we've already talked about, there's not as many active decisions being made out there.

Mike: 33:50

That's right.

Scott: 33:50

And it's all going into passive. And so I've listened to a guy by the name of Mike Green who talks a lot about this. And he says, Okay, well, as this keeps unwinding and eventually when passive becomes 80% or 90% of the market and you've got one active seller left, if you've got one person left that has all the shares in this passive investment needs to buy the next thing. Well, this last active person, like, what at what price are you going to sell it to them? A billion dollars a share?

Scott: 34:27

Sure. And is that because

Mike: 34:28

they have to buy it.

Scott: 34:29

Because they have to buy it, and there's no decision on the price. Yeah. And in in one of the things I listened to with Mike Green, he said like, the guy that was interviewing said, like, it's you have to watch out because if you're right on this, you're going to be end up dead because you're going to wind up with all the money and people are going to kill you. Because that's what will happen. And so for me, it's those flows that become one of the big dangerous issues is as long as there is more money going into this.

Scott: 35:04

And like we've already talked about this, a passive engine that is making zero decisions on what price to buy or sell, that can be dangerous for the whole market when this really tips over. And I don't know when that period would be when it tips over, but but I think it could.

Finn: 35:25

Like, you could we could figure it out if you because it's kinda track where it's going and how Yeah.

Mike: 35:31

Yeah. Salary So so we're you know, a lot of this is very technically oriented. And to some degree, like, we're not sure this is going to happen. This is what we think is going to happen. Like, let's bring it back a little bit to today and now Yeah.

Mike: 35:48

Okay. Where, you know, we get I get the question fairly regularly of, you know, what do you say to someone who just says, well, why why wouldn't I just buy a blend of the S and P five hundred and the Nasdaq one hundred and the TSX and the and the MSCI Global and just hold a passive portfolio at a lower fee because the exchange trade funds are very low fee. There's no active decisions being made. It's just the logistics of holding or creating the product in the portfolio. Besides some of these technical things, which we're not a 100% even sure are going to happen, we're concerned about it.

Mike: 36:30

But I think we should look at this from two perspectives. One from Fin, you are an active manager, and we are, the, you know, the users of active management. Like, why do we do that? Like, what is wrong with someone saying, well, I'm just gonna buy a blend of the S and P and the TSX Composite Index? So I'll start with you well, I'll start with you, Finn.

Mike: 36:54

As an active manager, what is your opinion on why someone should or shouldn't do that? Or

Finn: 37:02

Yeah. I'd I'd say a few things. I'd say, one one aspect of the index for investors, which I think is a little bit, people don't really think about because we haven't had a long bloody, horrible bear market for a very long time.

Mike: 37:19

02/2008.

Finn: 37:20

02/2008. Yeah. And how long was that? Two and a bit years of No.

Scott: 37:24

No. Eleven months.

Mike: 37:25

No. The the bottom of the market was in February, and it started in the February.

Finn: 37:32

And the S and P 500 was negative from 2001 till 02/2012.

Scott: 37:37

I think the longest one would be the tech bubble. The longest one in

Mike: 37:41

The o '1. Yeah. The 02/2001. Yeah.

Finn: 37:44

Yeah. Like, that's, like like, the last time we had, like, a long Yeah. Long. Like, where the index was flat for a very long time. That hasn't happened in, yeah, like, fifteen years essentially.

Finn: 37:55

Like, it was fifteen years ago that we started, like, the megatech US bull run, essentially.

Scott: 38:00

Yes.

Finn: 38:00

Yeah. It's the way that I would put it. And so people's memories are pretty short, especially in financial history. And there's a lot of periods where indexes really struggle, actually, because of the fact that they become way overbought. And then, you know, the market gets very expensive and it gets very concentrated.

Finn: 38:16

You can look at what's happening in The US right now as a good example of something that might be looking like that. And that's where active management really shines is where, you know, we can make those decisions to improve the portfolio so that it's ready for those types of periods, and that's what pretty much most active managers do. So that's that's one aspect is that I think that a lot of people's financial memories are very short, and passive management has worked incredibly well the last fifteen years. But historically, over a very long period of time, you can see these periods where you have very long stretches of either negative or flat returns on a variety of different indexes. And and, you know, and it does the other thing too, like, we talk about this for the global equity pool, like, The US exceptionalism trade and, like, you know, you can make an argument about about, you know, are US businesses exceptional or are their stock prices exceptional.

Finn: 39:09

Right? These are two different things maybe a little bit in some respects. Yeah. And and there are periods where The US dramatically underperformed. If I'm not mistaken, I believe the TSX actually outperformed The US, from nineteen o one to 02/2001.

Finn: 39:22

Of course, you're kind picking an endpoint for for the, The US index. It was pretty brutal. But yeah. So so the point of what I'm saying is that, you know, there's a lot of periods where the S and P 500 hasn't kept up. And so from an active manager perspective, you know, those are the periods where you really wanna be in active management because we can protect capital better.

Finn: 39:41

We can make active decisions to protect, our our clients through those periods. And you you can see that too during drawdowns. Right? Like, even in my portfolio, I won't name any percentages because we don't wanna put this through compliance, but we protect the capital very well through that that sell off that happened in April, and that's just a great hint as to what we can do through those more difficult periods. That's awesome.

Finn: 40:04

So that's one aspect that I would point to. The the other aspect is that, you know, and going back to that geographic discussion, like, you know, the the S and P five hundred is a bit unique in its own way because it does have, in general, a set of pretty high quality companies. I don't know if all every single company in there should be earning the valuation that it's currently getting, and I don't think that they're that exceptional. But if you look globally, like in Europe and in Asia and also I I would also argue especially in Canada, the value add for active management is very significant because there isn't that same set of high quality companies in the same way. So for example, in Europe, it's a lot of mediocre banks and utility companies, and it's it's been, you know, it's been it's been in but there's also a smaller subset of businesses that are just truly exceptional that Us active managers can find and invest in and provide good returns for clients, And also diversify your portfolio more so that you're ready for these periods where potentially The US maybe stumbles a bit, which, you know, we just had that episode on tariffs and all the, changes that are happening, in in The US.

Finn: 41:18

And, of course, you know, there's concerns about where that goes. So in Canada, in Europe, in Asia, there's a smaller subset of fantastic businesses that have an inherent ability to compound and grow over time. And then there's also a much larger subset of poor commodity like businesses that that that struggle over time. And so that's where active management can really add a lot of value.

Mike: 41:42

I think that is a very good point. That is something that, again, is not widely understood in the Canadian market. Yeah. Is that, you know, the S and P or TSX Composite, call it on a given day, two hundred forty, 250 companies in the index. And my numbers are out of date.

Mike: 42:00

But if you look at the number of businesses in that index that, a, earn a profit

Finn: 42:09

Right.

Mike: 42:09

B, pay a dividend, and c, like, have a minimum growth rate of profit and dividends at a low bar, even call it, like, 4% growth rate of profit and dividends, like, the number of companies drops to, like, 15. Yeah.

Finn: 42:29

Yeah. Yeah. It's really, really small.

Mike: 42:31

Well, in US In The US, that's not a problem. The S and P 500, like, it's probably 300 of the 500. But in Canada, it's like barely more than a dozen Yeah. That meet those qualifications.

Finn: 42:43

Well and and and this is so this actually reminds me of a study that was done by a professor at a university in The US, Henry Besenbinder, believe his name is. And he looked at who were the wealth creators of America over the last ninety years. He looked back as far as you could go on individual companies back to 1928 and the idea was let's look at all of the companies that have ever been listed in The US. Let's include the ones that because this is a problem. A lot of people look at an index and they say it's all hindsight bias.

Finn: 43:13

Right? Oh, these companies have done so well. Look at all these companies. And it's like, well, you're excluding all of the ones that went bankrupt.

Mike: 43:18

They went bankrupt. They don't

Finn: 43:18

exist anymore. Anymore. And trust me, there are tens of thousands of companies. I say there's 70,000 companies you can invest in today. I would probably estimate probably well over a million companies.

Finn: 43:29

You could have invested over the last probably way more than that, actually

Mike: 43:31

Yeah.

Finn: 43:32

Over the last ninety years that have just kind of disappeared. And so he looked at the last ninety years, and he saw he looked at every single publicly traded company in The US. That's not just the S and P 500. That's small companies, all sorts of companies. What percentage of the companies listed in The US created 100% of all the wealth in America, Do you think?

Mike: 43:54

I don't know why they're gonna say it's low. I'm gonna say it's lower than that. Okay. I've But I'm not sure. I'll call I'll say 25%.

Mike: 44:02

I think it's even lower, but I'll go

Finn: 44:03

4%.

Mike: 44:04

Four.

Finn: 44:04

Yeah. 4% of all of the companies in The US created 100% of all of the wealth. And point 3% of all of the companies in The US created half of the wealth.

Mike: 44:17

Point 3% created half. Yes. Wow. Point 3%. It was like a 120

Finn: 44:23

companies or something like that. And actually, more than half of all companies have a negative lifetime return. And, you know, you you can look at the so so this is a great a great place to start looking at these companies. What are the characteristics of these businesses? Right?

Finn: 44:39

That they created all the wealth. Right? Because that's what we should be looking

Mike: 44:42

for Absolutely.

Finn: 44:42

As active managers. And it's it's like, you know, these are businesses with a tremendous amount of durability, very strong economics, good management teams. They have a long track record and a great future, prospects of value accretive growth. Growth in itself is not good enough. The airline industry has grown tremendously over the last hundred years, created zero wealth for anyone.

Finn: 45:06

As as, you know, everyone, you know, knows airlines aren't great businesses to invest in generally. And this is a great example of own the best and leave the rest. Right? We as active managers have that opportunity to find these businesses that have those strong economics that the passive indexes don't have. He replicated this study not just in The US.

Finn: 45:26

He replicated it all across the world. It's the exact same sort of percentages. So our jobs as active managers is to find those companies, hold them, them very, you know, strongly, and, and then, you know, make changes when it it's clear that they no longer have the characteristics of the businesses that can create long term wealth.

Scott: 45:45

Wow. Would you say those companies are difficult to live without, difficult to replicate, and difficult to compete with?

Finn: 45:50

Absolutely, Scott. I I I think that and and, you know, this is another interesting thing because I then did my own study where I looked at, the TSX and the S and P five hundred over the last twenty years. All of the companies that have ever been listed. And the companies that were removed had an average return of minus over 50%, but the companies that stayed on the index over that twenty year

Scott: 46:13

period So this

Mike: 46:14

is the index, not the exchange? This is the index. On the index.

Finn: 46:17

On the index. So yeah. So so but yeah. The ones that were removed had a negative return of 50% Or more. Or more.

Finn: 46:26

Yeah. Okay. Yeah. Well, and that's another thing about the Besseinbinder study is that the most common return for a business was minus a 100%.

Mike: 46:35

In the index?

Finn: 46:36

In the yeah. Over oh, well, in The US, generally. But if I'm looking at sorry. Sorry. If I'm looking at the S and PTSX, the study that I did Yes.

Finn: 46:45

Looking at the S and PTSX and the S and P 500, when a business was removed, the average return was about minus 50%. And when the business remained on the index for that twenty year period, the average return was 200%. And this is really does come back to the durability of the business. Right? If if you can just conceptualize, this business will be around at least for the next twenty years.

Finn: 47:09

It has the characteristics that we look for, difficult to live without, compete with, and replicate. These types of things. Then they have the opportunity to push through difficult periods and get those really good returns. It's really it I think it really does just kinda come down to staying power for a lot of these companies. And that's where the opportunity for us active managers comes in is we have the ability to do the qualitative work on the businesses to really understand them that a passive index does not do, generally.

Mike: 47:42

Okay. Cool. So from a financial planning standpoint now, Scott, I'll ask you, and then I I'll pipe in with my own opinion. Like, you as an adviser making investment recommendations, like, you could recommend that that clients use passive and still do your job. That's a bit of a miss there's a misconception in the industry that financial advisers only use active managers because that's how they get paid, and that's not true.

Mike: 48:13

Like, we could use a passively we could use ETFs or index funds or anything else and still do, you know, our same level of income and revenue. So that that is a misnomer that that financial advisers use active because they get paid that way. That's not true. Yet we still don't generally. There are some people, I'll qualify.

Mike: 48:36

There are some financial advisers who do use passive strategies, ETFs, etcetera. You don't, I don't. So why don't you? Like, what is the argument in your opinion for for why you use active versus passive?

Scott: 48:50

So I well, I get questions all the time, especially clients coming to me saying their kids should be using ETFs, telling them they should be

Mike: 48:57

using them. Yes. And there's the Warren Buffett. Warren Buffett has a quote out there somewhere that and I'm gonna butcher the quote. So it's not a

Finn: 49:04

quote, but it's Paraphrasing.

Mike: 49:07

The paraphrase of, you know, Warren Buffett. Said, well, if your average person just bought the S and P 500 and did that for the rest of their working life, like, they would they would do well. And I don't disagree with him, but that's where a lot of this comes from too with our, you know, our clients say to their young adult children, use ETFs or use passive.

Scott: 49:27

Yeah. And I think the thing is is a lot of people assume that our industry is precise. It's not. Like, we're it's kind of like weatherman. Like, there's a lot of times where people are wrong and and it's it's you're kind of estimating, you're predicting.

Scott: 49:45

And so I I don't think the the argument that people make of that, yeah, you if you just held the S and P 500 for the whole time, you'll do fine. That's true. It's very I think it's like almost an argument between rational and reasonable. Like, people think that you're irrational for using active management because the fees are high. But the answer is it's just a reasonable option.

Scott: 50:10

And passive is reasonable too. But where I think it goes off the rails is to that Buffett quote is, well, yeah, you got to be there for the full time. And I think the for me, the active piece has all the things that you just talked about, Finn, of being able to say, well, we made a decision because of this and this and this. Because when times are tough, what people are looking for is reassurance that something is happening and that they're going to be protected. Of the sayings I say to people all the time is my job is not to make all your money.

Scott: 50:50

Like, you make your money.

Mike: 50:51

That's right.

Scott: 50:52

My job is to help it grow, but make sure that you never wind up poor.

Mike: 50:57

We are a steward Yeah. Of the money that they have saved.

Scott: 51:00

That they have saved. And and they did all the work and this is all their hard work.

Mike: 51:04

That's right.

Scott: 51:05

And so so I need in in my opinion, I need somebody who can be active. And it's not about what it's gaining on the upside. It's more about what's happening on the downside. When things are unwinding, do we have the ability to protect it? And my concern has always been on the passive side is, you know, if it's selling, if that act if that passive thing is selling, what price is it selling at?

Scott: 51:32

Well, it's selling at the next price. It's not making a decision. And there's nothing There's not as many guardrails for when there's a We call it a run. But when everybody's selling out of that fund, there's nothing really guardrailing it. Whereas active has that ability to put guardrails on that.

Scott: 51:53

And that's something that I think is really important. And and we've said it before, it doesn't matter if your strategy is right or wrong at the end. It matters that people are still there to experience it. And so, so, you know, we can back test all we want and look backwards and say, this is what you should have done. But what we're talking about is the future and we don't know.

Scott: 52:18

So we just have to have a strategy that we know that can ensure that people will be there when it's time to redeem it and and reap the rewards of that strategy. And my concern with active is I don't or with passive is that I don't think you know, people coming to me saying, you know, they they don't need you as an adviser. They should just own an ETF on Questrade and passively invest it and they're good. Yes. You can do that, but you need to be sophisticated enough to know how to undo it, how to sell.

Scott: 53:00

Like anybody I I kind of think of it as gambling. Anybody can sit down at a blackjack table and place a bet. But nobody or at least me, I'm not good at it, but it's it's knowing how to make the bets and when to hit what cards. It's it's that undoing that will will make or break your bet. Yeah.

Scott: 53:25

And so it's all the strategies, I think, that are really important.

Mike: 53:29

Yeah. I think you hit on something for me that's really important, which is that idea of you know, if you're right, but no one's left to be right for, it doesn't matter how right or not right you are. And that's something that I, in many ways, I've learned the hard way and just over years of experience is like, my goal is my goal or my definition of success is not beating the index. I don't know, Fin, if your portfolio will beat the index over the next thirty years. I don't know that.

Mike: 54:05

And I'm not particularly concerned about whether it does or doesn't. What I'm concerned about is will people meet their financial goals. And so when someone says, well, just buy the S and P 500 or the TSX Composite. Okay. Fine.

Mike: 54:21

Like, I'm not saying that that's a silly thing to do or a bad idea. What I am saying is that they won't do that. They will start doing that, but over time, when things get difficult, they won't have the knowledge or the insight of the guidance or when to hit or when to double down or when to do it, and they'll bail. And so if the S and P five hundred outperforms you, Finn, by two percentage point compound annual over the next thirty years. Like, I don't really care.

Mike: 54:52

What I care about is that everyone is still doing their process and meeting their financial goals.

Finn: 54:59

Well, and this this is something that I think I feel like we mentioned in I can't remember which which episode we were talking about this, but, like, Morgan Housel talks about this, that you you you wanna be financially indestructible so that when times get tough, and we haven't seen tough times like we were talking about, we haven't really seen tough times in about twenty five years at least. And that's when the, you know, the value advice really kicks in because that's when a lot of people who, you know, don't have financial professionals behind them, may panic and may make the worst decisions at the worst times. Yeah. And these these difficult periods, they aren't like, people always are imagining, like, oh, the world is the exact same and stock prices are 50% lower. That's not what happens.

Finn: 55:47

There's always a real scary actual thing happening in the world.

Mike: 55:52

And That we don't see coming.

Finn: 55:53

Yeah. That no one no one really sees coming and is is actually like, it does feel like the world is about to implode. Right? And, you know, the, you know, the value of advice is really in those moments being able to say, like, you know, this is not the time to sell. This is the time to maybe even double down.

Finn: 56:11

And, you know, actually, I just pulled up this this this thing that I I had sent out to some some folks. Do you guys know about Rick Gurren? Rick Gurren and Berkshire Hathaway. So this is a great story. So at the beginning of Berkshire Hathaway, there was actually three people.

Finn: 56:25

There's Charlie Munger, Warren Buffett, Rick Gurren.

Mike: 56:28

Don't know this.

Finn: 56:29

Okay. So this was in the nineteen sixties, and Rick is all over the early history of Berkshire, but most people haven't really heard of him.

Mike: 56:36

Never heard of him.

Finn: 56:36

And the three of them all made investments together, But the one difference was Rick was in a hurry. Right? He wanted to get rich quickly. And he invested very heavily on margin, and in 1974, the bear market completely wiped him out, essentially. And he sold all of his shares to Warren and yeah.

Finn: 56:54

Exactly.

Scott: 56:54

At, like, sixties 60¢ on the dollar or something like that. Something ridiculously

Finn: 56:58

Something ridiculous. Yeah. And, you know, Warren said that Rick was dressed as smart as us, but he was in a hurry. And, you know, the the thing that's interesting about Warren and Charlie is that they basically went through their entire investment career at about 70% of their potential because they knew that they were focused on endurance. Right?

Finn: 57:19

They knew that the the best thing to do wasn't to optimize returns in any given year, but optimize the highest return you can get over the longest period of time because it's that longest period of time that really creates wealth. And when you have those huge drawdowns of, you know, 50%, you need to be able to have set yourself up. You need to have a financial steward like you were talking about for yourselves. They can get you through those periods because that's how you create real wealth over the long term.

Mike: 57:45

I think to you mentioned, Scott, well that, you know, our clients will say, oh, to their kids, oh, you should, you know, you could just buy an index. And there is some truth to that. And here's why, and here's why it breaks down in my opinion. Because I lived it myself, right? Like I'm a very technically oriented person.

Mike: 58:06

My I majored investment finance in school. I'm a CIM and all that. And I started my career in 1998, which happened to be a bear market here as well. But really, the o one, o two experience was was, in retrospect, very enlightening. And it's this, like, in 02/2001, you know, I would give people a lot of advice and, you know, don't worry.

Mike: 58:32

Think long term. These are the percentages. Here's all the statistics as to how things recover and all that. But guess what I didn't have in 02/2001? I didn't have any money.

Mike: 58:46

Like, I had a group RSP that was probably worth $60 or something because I was five years into you know, not less than five years into my career. And so a 50% market downturn meant nothing to me. It did on paper, learning, academia. Right? Yeah.

Mike: 59:05

But if you have $2,000,000 invested in the market and it goes down 50%, that is a whole other ball of wax. Right? Like, what does it take? So if you have $2,000,000 and I know that it didn't finish the year down 50%, but, you know, peak to trough, it was down 55%. So if you have $2,000,000 and suddenly it's a million dollars, like, what does it take to earn enough money, live within your means or first pay tax.

Mike: 59:39

So earn it, pay tax on it, live within your means and save a million dollars. Like most Canadians never do it. Never. So it's okay for kids to do the passive strategy because it's just like, just bank, put money away. Like just put money away, don't look at it, don't think about it, doesn't matter.

Mike: 59:57

And that's true. Yep. It's true. But when you're 50, 60, 70 and it's meaningful, like, that is going to break down in a big way because people are not going to stick with it. They're not gonna do it because their their million dollars is now 500,000.

Mike: 01:00:14

And it is extraordinarily emotional, and you can kiss your academia goodbye

Scott: 01:00:22

at that That goes to to what I was talking about before is it's if we look at back tested, you know, we see things all the time, stats put up at conferences and everything about, you know, if you started in in 1990 and owned the S and P until now for thirty five years or thirty years, your money would be worth this much. But it's that in between In It's the story in between of the periods where you've had those drawdowns. And, you know, I have clients that will phone all the time and they're like, I lost money. And it's like, well, where did it go? And it's but it they did it but it's because they and I am I'm joking, but it's because it it it all it did was draw down in value.

Scott: 01:01:10

But it it's not loss. Because as long as we can help them know not to sell it and to be able to have a really good structure of, you know, cash that they can access and and, again, a lot of the financial planning pieces, then that shouldn't really matter. Because if we can hold it, if we own durable businesses like you've already talked about, Fin, if we own these durable businesses, then coming out the other side in a couple of years, everything should be back to normal, hopefully. And so but we have to be there to experience that. Yeah.

Scott: 01:01:47

And if we sell out and leave, then there is no chance that you will be there to experience it. Or it's the cycle of market emotions. You you'll you'll sell out because you feel bad, which is at the bottom of the market. And then what you'll do is you'll wait until you feel comfortable, until you feel better. You'll you'll see the market come back and you'll be like, okay, I'm comfortable.

Scott: 01:02:12

I'm going to get back in. Well, all you've done is sell low and buy high. It's the opposite of what you should do. The Dalbar study that we've seen before talks about, you know, I can't remember what the average was. I think the average rate of return for mutual funds was 8% or something like that.

Scott: 01:02:31

But the average client experience of rate of return was about three.

Mike: 01:02:36

Right. There's an even better I mean, it's dated now. But there used to be a big mutual fund from Fidelity in The US. It was managed by Peter Lynch, who is a legendary active portfolio manager. And he was the first person and maybe only person still who had a twenty year track record of, I think it was above like 20% compound annual.

Mike: 01:03:06

So for twenty year mutual fund had a twenty percent compound annual rate of return. But how many investors achieved that? Zero. None. Because no one bought in at the beginning, stayed the course and were there at the end.

Mike: 01:03:29

Like, is not one investor in that fund over the twenty year period who achieved those rates of return because they all left at various points. When things got difficult, they left. Or they bought when because it was volatile. Or they bought when it was already, you know, kicking ass and taking names. They're like, oh, I gotta get in on this.

Mike: 01:03:48

And I'm sure they did okay. Yeah. But they didn't come anywhere close to that because you you have to have a connection to what is it.

Finn: 01:03:56

I wanna pick up on two things that that you said. One is that, you know, you're talking about like academic studies and, you know, like, I think that there's a whole bunch of academic studies that say that, well, the best thing to optimize your returns over the long term, what you really should do is you should lever up and borrow, like, three times your money and then put it into the index. And, know, it goes to zero multiple times over, you know, a fifty year period, but just do it again and and eventually you'll be better off. Nobody's gonna do that. That's absurd proposition.

Finn: 01:04:28

Never do it. And and not only that, but that's gonna that, like, you know, that that takes out the entire, like, human lived experience out of it. Like like, you you have bills to pay, you have a mortgage to pay, and you're like, oh, yeah. Went to zero again. I'll just rip it up again.

Finn: 01:04:41

Like, it's just an absurd proposition. Anyway, and then the other the other thing too that I I I think we've kind of glossed over, but we've, you know, just wanna hit it directly is that, you know, this is where, like, customized solutions for different investor types is something that indexes are really not good at. And this is where, you know, different types of investors have different investing needs. They have different investing horizons. They have different investing personalities.

Finn: 01:05:08

And that's where, you know, being able to build these portfolios in different ways so that we can protect capital in different markets or be able to generate different types of returns in different periods. That's that's where you can add a lot of value as well. And that's beyond just the mutual fund. Right? That's that's the whole financial picture.

Finn: 01:05:24

You need someone there to help you through the whole thing.

Scott: 01:05:27

Absolutely. Yeah. One thing I was gonna ask you about, Mike, because you're kind of the technical one too, but the argument that I get from a lot of people about going to the ETF route and everything is low fees. And that the benefit of it is low fees.

Finn: 01:05:44

And

Scott: 01:05:45

that well, it's Questrade commercials. Yeah. Talking about how you're just giving your money away. I don't believe that that's true. I think it ignores the value of financial advice.

Scott: 01:06:03

But do you look at fees being a driver of it?

Mike: 01:06:06

A driver what? The growth in popularity? Yeah. Yes. I I think it's a huge part of the growth in popularity for sure.

Mike: 01:06:17

And fees fees do matter. Like, I know there's a lot of people in our profession who say it doesn't matter. It doesn't matter. Well, it it does. Like, fee fees do matter.

Mike: 01:06:25

Yeah. But it's not a race to the bottom either. Like, you need to get value. And that's what participant like, clients or investors need to analyze is if I'm paying 1.7% or something, what am I getting for it? If the answer is simply active management, there's an argument that that's too high.

Mike: 01:06:50

But when you deal with a financial adviser who is charging 1.7, like, you're getting you should be getting more than active management. You should be getting financial planning. You should be getting the keeping you on track part of of the component and make sure that you that you meet your goals and estate planning and making sure that your wealth is gonna transfer in an in an efficient way. And all these things along the way, are part of I'm picking 1.7 at the end, but of that of that fee.

Scott: 01:07:22

Yeah. I think But if

Mike: 01:07:23

you get if you pay 30 basis points for an ETF, that's fine from an investment standpoint. But again, you have to get to the end point. You have to get across the finish line. And the finish line isn't retirement either. It's like it's death.

Mike: 01:07:37

Right? Like, you need to do this all the way along the course. And I my experience has been that people don't. My experience has been that it is worth paying more possibly at the consequence of lower returns, possibly, but not necessarily lower risk adjusted returns.

Finn: 01:08:02

Yeah. And and and and you're you're like, you you kinda you kinda said this, but I wanna kinda dive into it a little bit more. Like, you know, in lower returns, but you have to look at the whole financial picture of, yeah, like the estate planning, you know, getting the making sure that there's, you know, generational wealth transfer is done correctly, all that other kind of stuff.

Mike: 01:08:20

Tax minimization. Tax loss selling.

Finn: 01:08:22

Like, if you if you if you packed it all in together, there's a lot of things that can add value over the course of someone's entire life.

Mike: 01:08:30

Yeah. Enormously. That is worth a lot more than the the spread. Like, 1.7 includes everything. Let let's say the actual investment management fee is one out of 1.7 or or 90 basis points out of that.

Scott: 01:08:46

Yeah. Your range probably one and a half to 1.9 something.

Mike: 01:08:49

Yeah. Yeah. Yeah. Yeah. All all but Depending on how

Scott: 01:08:52

much money you have. Yeah.

Mike: 01:08:53

But is it worth paying the spread between 30 basis points for the ETF and a 100 basis points for the active management? Is it worth it to pay that spread possibly at the at the expense of lower returns or even directly there is because you have that spread in in fees. So you are gonna possibly, you know, on all else being equal basis earn less, but you get to the finish line and you achieve your goals and it like that's infinitely worth it.

Scott: 01:09:26

Can I can I answer your kind of rhetorical question of is it worth it? I I I think the answer is it depends who you are. You know, as an adviser, we always talk about we work with people who are financial delegators. They don't have knowledge about this. They don't have time to deal with this, so they come to us to help them deal with this.

Scott: 01:09:49

But so it's worth it for them. But if you're a very sophisticated investor, you love to do this on your own, yes, you can ignore the paying the management fee because you can pay that to yourself by managing

Mike: 01:10:05

That's right.

Scott: 01:10:05

A portfolio of passive investments and trade or or you can trade your own stocks. So there's that do it yourself person that has the sophistication. And assuming they have the sophistication and know what's going on, then they can keep themselves on track when times are bad. But that's not the largest portion of the population. The largest portion of the population doesn't understand a lot of this stuff.

Scott: 01:10:31

And so and there are we we call them collaborators. There's there's another portion of the population who are they kinda wanna do some of it on their own, and they kinda want something in between. So there's there's different people. I I I think investing is not one fits all. It's one fits one.

Scott: 01:10:49

Whatever type of person you are, that's the you need to find the strategy that fits who you are. Yeah. And I I think a lot of the Questrade commercials that we see or or people, you know, people's clients' kids telling them they should do this. Well, maybe they should, but maybe they don't want to because maybe that's not their personality. Yeah.

Scott: 01:11:11

And so it again, it's it's one fits one. It's not one fits everyone.

Mike: 01:11:17

Yeah. Think that's a very good point.

Finn: 01:11:20

We are at, I think, like an hour and a half into this. We try to wrap it up a little bit?

Scott: 01:11:25

Yeah. The only thing that I was going to touch on is one of the reasons why fees are really low in all those passive investments is because behind the scenes, like Vanguard and BlackRock lend out all their shares for people who are short selling. And that's what allows them to keep their fees really, really low. Mhmm. Mhmm.

Scott: 01:11:45

I thought that was kind of an interesting point, but we don't know. It is. Is. Because I don't think I'm not sure.

Mike: 01:11:52

I'm sure I've heard that, but I don't actively know that.

Scott: 01:11:55

Yeah. Like, that's I think that's the piece that a lot of people miss is behind the scenes, the reason that these companies are allowed to keep their management fees so low for a passive investment is because they're not trying to make their money on you investing in their passive investment. They're making their money on the other side. It's like a bank. They're making their money on the other side lending out all the securities that these passive investments own.

Scott: 01:12:23

And they're making short sellers. To short sellers, and they're making their money on the spread. I didn't know that.

Finn: 01:12:29

You gotta think about the consequences just going back to, you know, the flows discussion. You know, when the flows turn negative, you're like, what happens to, you know, having to unwind all these?

Scott: 01:12:37

Yeah. And that's my big concern about

Mike: 01:12:40

Well, yeah. Okay. So I'll I'll go where I was gonna go. And I don't have I don't currently have the documentation to prove this, but I've heard this that there's so much passive buying going on and it's all kind of quote unquote on paper. Like, not like they are buying the shares, but it's gotten so large that does Microsoft have a big enough float to actually satisfy the demand of the purchasing.

Mike: 01:13:10

And I've heard that they and I'm picking on Microsoft, it doesn't matter, it could be any of these companies.

Finn: 01:13:13

Yeah. They're all like fifties percent owned by some sort of passive

Mike: 01:13:17

Yeah. So BlackRock. You know, there's there's some some academics out there that says their float by and large is not big enough to to sustain the demand of passive buying because on paper, the index says buy more of this. And so there's a lot of synthetic shares out there that are rep you know, replicating the price of Microsoft or Nvidia or whatever the case may be, which on the upside is fine. But on the downside, it's not.

Mike: 01:13:49

Because if you it's basically leverage. You're leveraging the number of shares outstanding, but not adjusting the price for the leverage. So when you get to the downside and it all starts selling, theoretically, in some cases, there's enough real and synthetic shares to send the price to zero. Even though the business clearly has value. Even if it's just office equipment, plant and, you know, pencils and paper.

Mike: 01:14:15

Right? Yeah. There's like there's clearly value in the business.

Finn: 01:14:18

I'll definitely be buying it at that time.

Scott: 01:14:20

So so that's my point about understanding that that behind the scenes, they're lending out the shares. Because if you think about it, what can be happening is Vanguard can be lending out shares to a short seller who's selling those shares to the ETF that BlackRock owns. Yeah. And so, basically, you've got one share that's now being owned twice. And so it leverages the number of shares that are out there, and and it's not actually true.

Scott: 01:14:55

Because Vanguard's reporting that they have that share. This short seller has borrowed it and sold it here, and now they're saying that they have that share as well. Right. So it is doubling the amount of shares that are

Mike: 01:15:12

out there. So how do they close how does the short seller close the position? Like, happens if the short seller is right and they win, but they have to buy the share?

Scott: 01:15:23

They gotta go buy it somewhere. Somewhere?

Mike: 01:15:25

Yeah. Where? Like, they're not gonna buy it they can't buy it back from the passive because they can't sell it.

Scott: 01:15:32

So that's where this that's that's where this all can blow up. Is that when this has to unwind, how does it unwind and does it blow up? And it's all fine as long as there is more money coming in

Finn: 01:15:49

As long

Scott: 01:15:49

it's positive flows. And again, like, that's easy. You you talked about it. Everyone's now got a a defined contribution pension plan where there's just these every day people go to work. There's money taken off their paycheck.

Scott: 01:16:08

It goes into these, and it just keeps buying. But what happens when there is a whole bunch of people who say, I need out?

Mike: 01:16:17

Short. Short. Short.

Finn: 01:16:19

I I feel like the like the whole world is built on positive flows in every respect. Like, you know, like we need population growth. We need economic growth. We need people to keep buying stocks, you know, and we need all yeah. Speaking of, like, you know, ETFs short selling stuff, there was a cannabis index in Canada like Horizons marijuana and Yeah.

Finn: 01:16:40

Something like that. And they had like a something absurd. It was like a 12% dividend yield on it or, you know, income yield or whatever. And then you look like, cannabis stocks have dividends?

Mike: 01:16:51

Don't I know.

Finn: 01:16:53

Then you and then you you go in and you like read the prospectus and it's like, oh, like we from time to time, we allow for people to borrow the shares that we own where we get paid an interest on the borrowing. Right? Like you would, know, like you're borrowing money from a bank, you know, you get paid interest, whatever. They will borrow the shares from us and they'll they'll you know, we get we get we get income off that. And they were so heavily shorted.

Finn: 01:17:18

These cannabis stocks were so heavily shorted that that, you know, people were willing to pay a lot of money to short it. So it had like a 12% yield because people Because it's going to zero. It's going to zero. And and it and it's also it's a it's a yield it's a trailing twelve month yield. It's not a forward twelve month yield.

Finn: 01:17:37

Right? So, you know, you're looking at it so, like, you know, maybe the maybe the call it the unit price was $10. It was, like, $10 a year ago. And, you know, maybe maybe the company was getting 10¢ per unit in income. And then the shares went down 90%, and now it's a dollar.

Finn: 01:17:55

And so the trailing yield is still 10¢. Right. But the value has collapsed to to a dollar. So now your your trailing yield is 10%. It's pretty stupid.

Scott: 01:18:05

I think we leave it.

Finn: 01:18:06

Think we're to I

Scott: 01:18:07

think let's Our problem is

Finn: 01:18:10

that we're very we we we have a lot to say and the conversation's too easy.

Scott: 01:18:14

Yeah. I enjoy it. That's kind of the point. That's kind of the point. Yeah.

Finn: 01:18:18

Yeah. That's a good problem to have. Yeah.

Scott: 01:18:20

Yeah. So I don't know how we wanna recap it.

Mike: 01:18:25

That this should be part of the recap, which is for a reminder for people out there. This is intended to be sort of a conversation that we would have with all of our clients or people that we interact with on a daily basis. Like, this isn't meant to be a lecture. Mhmm. No.

Mike: 01:18:42

It's meant to be a discussion. And so, yeah, I kinda we do kinda go off the rails a little bit here and there, but that's kind of the point. That's that's why we are that's why we're doing this in the first place is to have an open, honest, unscripted discussion. Yeah. So bear with us as we as we proceed this way.

Scott: 01:19:02

Yeah. I think, like, kind of to sum up some of my thoughts is I think there's a lot of stuff going on in the passive world that people don't understand. I think it's but it doesn't mean that it's wrong. And and if it's something that you're interested in and you like and it and it fits with your financial goals and plan, then then keep doing it. But it doesn't mean that it's what your neighbor has to do as well.

Scott: 01:19:33

I think, again, it's it's very one fits one. And I think that you you can't ignore or just use fees as an excuse to ignore the value of financial advice and making sure that you stick to your plan for the long term. It's that Buffett quote of of of making sure that you're you're really looking at the long run, being the best for the longest. So I think that's kind of my two big takeaways.

Mike: 01:20:03

Yeah. I would echo it. Like, as someone who has actively actively used active management for the past, you know, what, twenty twenty to twenty five years, no one has ever heard me say that investing in an index is is stupid or wrong. I have never once said that. I don't think that delegating the decision and just investing in a in an index is a bad idea.

Mike: 01:20:30

What I think though is that you people won't consistently do that over the long run because when things get really, really hard, which we again, we haven't really had for fifteen years, and then it was o one before that where it was really hard. Typically, people don't do that. It's very difficult. Investing is very emotional. And as you age and achieve success, the dollars at play become go from being almost insignificant to being the most significant thing in your life next to, like, your kids.

Mike: 01:21:03

Right? And, like you need someone to help you get over the finish line, which again doesn't mean you have to use active. Like you could use a financial advisor and use passive. But what I find is that making a connection for people between what they own and why this is gonna help them achieve their goals is what gets them over the finish line. And you can't do that with a passive.

Mike: 01:21:31

Like because if someone asks, why would you own this business that isn't profitable and doesn't pay a dividend and seems, like the management team is doing some weird things. You go, well, I I don't know. That's just what the index does. People aren't gonna make good decisions on that. Whereas if you can explain why we're doing what we're doing, that will get you over

Scott: 01:21:50

the finish line. Yeah. Which, again, makes me appreciate everything that you do, Fin. Right.

Finn: 01:21:59

Yeah. Well, mean, yeah, like like knowing what you own is a really critical part of of investing and you you can't really do that with an index. And, you know, like we were talking about, like the last the last fifteen years have been exceptional, an exceptional period for for specifically US megatech companies. And, you know, previously before that, this was a phenomenon that didn't really exist. And and this that doesn't mean that it's going to continue.

Finn: 01:22:24

We don't know that it's going to continue. And increasingly, you're starting to see really interesting opportunities outside of The US and in different areas of the market that haven't gotten nearly as much love. And those are areas where passive management or passive investing Passive management is kind of a misnomer, isn't it? Managing it. But that, you know, in these other areas, you can create a tremendous amount of value as an active manager by, you know, being very selective on the businesses that you you can own.

Finn: 01:22:56

And, you know, the the examples that we gave around, like, Bessebinder study showing the very small percentage of companies that are actually driving all of the results for for wealth creation really give a great example of what active management can do over over the long term. And, yeah, like, you need to you don't you don't wanna be optimizing your financial situation for any given year. You need to optimize your financial situation for your entire life. And that's where having financial stewards, such as yourselves, Scott and Mike, are are essential.

Mike: 01:23:31

Love the analogy, I'm gonna steal it in the future, is the blackjack table. Not that we wanna associate with gambling, because certainly what you do is not gambling. But in the analogy, you have six people sitting around the table and they're all playing the hands. Are their odds all the same? No.

Mike: 01:23:48

They're not. Because active people will say, well, I know when to split aces and I know when to double down and and I know when to fold or stay. Yeah. And it changes your odds of success despite we're all at the same table.

Scott: 01:24:04

Yeah. We can all put put the chip on the table. Yeah. But the outcome after that is what is going to determine your success. Everything in this podcast is meant for entertainment and educational purposes only.

Scott: 01:24:22

It is not financial advice. And all the opinions that we express in this podcast are not necessarily the opinions of the companies that we work with or affiliated with. So bear with us while we discuss these topics and remember that financial and investing decisions are different for everyone and you should consult a financial professional or do your own research before doing anything for yourself.

Mike: 01:24:50

Well said.

Finn: 01:24:51

Thank

Mike: 01:24:51

you. I also like to say, trust me, when I'm giving you financial advice, you will know it. It will be one on one and in person and it will be clear that this is financial advice. This is not. You will

Scott: 01:25:04

know exactly what I'm talking about.

Mike: 01:25:05

Yeah.