A Canadian pension fund manager is evaluating two investment strategies for its large-cap equity sleeve: an actively managed fund with a 1.20% MER and a passively managed ETF tracking the S&P/TSX Composite Index with a 0.15% MER. Both strategies are expected to generate a gross return of 7.00% per annum over the long term. Assuming a 25% tax rate on capital gains (for an institutional fund, this simplification is for illustration) and ignoring other fees, what is the approximate annual net return difference in favour of the passive strategy?

Question: A Canadian pension fund manager is evaluating two investment strategies for its large-cap equity sleeve: an actively managed fund with a 1.20% MER and a passively managed ETF tracking the S&P/TSX Composite Index with a 0.15% MER. Both strategies are expected to generate a gross return of 7.00% per annum over the long term. Assuming a 25% tax rate on capital gains (for an institutional fund, this simplification is for illustration) and ignoring other fees, what is the approximate annual net return difference in favour of the passive strategy?

Answer options:

• 0.90% ✅ 1.05%
• 0.79%
• 0.86%

Correct answer: 1.05%

Explanation: The net return for the active strategy is 7.00% - 1.20% = 5.80%. The net return for the passive strategy is 7.00% - 0.15% = 6.85%. The difference in favour of the passive strategy is 6.85% - 5.80% = 1.05%.