Montreal, Canada

There’s no doubt that over the longer term, fees make a world of difference and can impact your bottom line. Nobody likes forking over a big fee for an investment and passive investment management companies have capitalized on this trend since 2000. When it comes to investing, lower fees can make or break your performance in a tough year for the markets.

Mutual fund fees have compressed over the last decade but are still no match for ETFs and index funds. Canadians have the worst deal of all, paying the highest expenses for mutual funds than any other major industrialized economy. And investors are tired of high fees.

Yesterday, I commented on the emerging markets and how this asset class has dominated the performance tables over the last decade. Though I’m bearish on most things with a risk-bias, I still like emerging market stocks because that’s where the earnings growth resides coupled with strong balance sheets in many countries that represent the benchmark.

I like emerging market stocks (not the debt) because most currencies are undervalued and over the next decade they’ll rally against the major currencies like the dollar and the EUR. I also think growth rates will remain superior to sluggish and debt-plagued Western countries.

I recently purchased a small 3% position in my managed accounts in VWO or the Vanguard Emerging Markets ETF. Like all stock-based products, I apply a 20% stop-loss just in case markets violently collide – something that’s become extremely regular since mid-2007.

ETFs, unlike open-end mutual funds, are also generally more tax-efficient because they don’t pass on those potentially fat distributions to investors following a redemption or sale. They’re also much cheaper than actively-managed open-end funds, which tend to turnover portfolios much more as opposed to passive indexing. Higher turnover means higher expenses.

Vanguard Group, the low-cost giant based in the United States, currently has the most inexpensive emerging markets ETF.

Traded under the symbol VWO, the ETF tracks the benchmark MSCI Emerging Markets Index and sports a 0.27% total expense ratio; that’s pretty darn cheap compared to the iShares Emerging Markets Index or EEM, which levies 0.72% for the same portfolio.

VWO also offers a high degree of daily trading volume – usually implying a better bid/ask spread than those ETFs with less trading volume.

Over the last five years, through July 31, 2010, VWO has earned 12.4% per annum compared to 11.8% per year for EEM. That performance differential lies strictly in fees. Both portfolios hold the same benchmark weightings. Meanwhile, according to Lipper, emerging market stock mutual funds gained 11.1% per annum over the last five years – lagging ETFs and index funds because of higher fees.

I still believe active portfolio management deserves a place in a diversified portfolio because indexing won’t beat the market – it’s designed to replicate the market. Sure, most mutual funds have trailed the benchmark and there’s no questioning the results over time; indexing wins. But some stock and bond fund managers have trounced their respective benchmarks over the years and can add alpha or excess returns in up and down markets.

Bill Gross, Dan Fuss, Don Yacktman and Bruce Berkowitz are just a few of those five-star managers that belong in your portfolio.

Indexing is great but it’s not great all the time; adding successful risk-adjusted, actively-managed products to your portfolio mix will reduce volatility and over time, boost your total return.

I’m off to Barcelona tonight for holidays. I’ll blog from Spain on Thursday.