Archive for October, 2012

This and That: Financial Risk, Kevin O’Leary and more…

October 5, 2012


Bernstein’s lesson from the Financial Crash

In an interview with Money magazine, author William Bernstein explains the key lesson of the financial lesson that can be applied to the asset allocation of folks at or nearing retirement. One could argue that even retirees need a healthy allocation to stocks to survive the ravages of inflation.

Kevin O’Leary: TV Billionaire

Mr. O’Leary may make for great TV but his business and investment records are quite ordinary says this hard-hitting story in the Report On Business Magazine.

Money Advice from the Great One

The Financial Post reported that Wayne Gretzky speaking at an event organized by TD Waterhouse said that he likes to avoid leverage, keep most of his money in a bank account and not risk more than 10% of his wealth on any investment opportunity. It might be good advice for sportsmen who have a general tendency to blow through millions but I’m not sure if the Great One’s financial strategies are applicable to the other 99 percent.

Your Financial Toolkit

The Financial Consumer Agency of Canada has put together learning material to help Canadians get a better handle on their financial lives. The material covers the entire waterfront from budgeting to taxes.

Modest Returns from Stocks and Bonds

This column in The Wall Street Journal says that investors should expect modest returns from bonds and stocks.

The secret to Buffett’s extra-ordinary returns

Over a 45-year period, Berkshire Hathaway has beaten the S&P 500 index by an annualized 10 percentage points. How did the company manage to compile such a stunning record of outperformance? The Economist magazine reports on recent research that points to low-beta stocks and low-cost leverage provided by float of insurance companies as reasons for Berkshire Hathaway’s investment returns.

Around the Blogs

A couple of week’s back I attended the Canadian Personal Finance Conference 2012 organized by Preet Banerjee and Krystal Yee. It was a wonderful opportunity to meet so many Canadian bloggers. My Own Advisor provided an excellent synopsis of the conference.

If you are in the market for a new credit card, Canadian Money Forum is running a limited-time offer on a Sony MasterCard.

Michael James on Money shows that a back test of using stock options to limit stock market risk produces poor returns.

Avrex on Money, a new financial blog, compares three dividend ETFs to determine which one is suitable for a portfolio.

Vanguard US ETF Benchmarks are Changing

October 3, 2012


Vanguard’s US-listed ETFs such as Vanguard Total Stock Market Index ETF (VTI), Vanguard MSCI EAFE ETF (VEA) and Vanguard MSCI Emerging Markets ETF (VWO) are popular among Canadian index investors because they offer a cheap way to diversify into global stock markets. Investors in these ETFs should take note of a recent announcement by Vanguard that these ETFs will shortly switch from tracking indexes provided by MSCI to indexes provided by Center for Research in Security Prices (CRSP) for the US market and FTSE for international markets.

Vanguard says that the change will help it save millions in benchmark licensing fees it currently pays to MSCI Inc (in response to the news MSCI’s stock dropped by more than 25%). In turn, due to Vanguard’s ownership structure, investors can expect the savings to pass through to them over time in the form of lower expense ratios. VTI, VEA and VWO currently charge a MER of 0.06%, 0.12% and 0.20% respectively and investors can expect these MERs to fall even lower!

A key concern when an index mutual fund or ETF changes its benchmark is turnover. Turnover negatively impacts investors through a one-time increase in trading costs and could trigger capital gains distributions. Vanguard does expect some extra turnover from the transition but says that it doesn’t expect any capital gains distributions.

Impact of Benchmark Change on Vanguard Emerging Market ETF (VWO)

Unfortunately, it does look like the change in indexes needs to be analyzed carefully. The new indexes that VTI, VEA and VWO will track look quite different from the MSCI indexes that they currently track. Let’s consider the case of VWO, which currently tracks the MSCI Emerging Markets Index and will start tracking the FTSE Emerging Index. Here’s a comparison of the annual returns of the two indexes for the past 10 years:

Year FTSE EM Index MSCI EM Index Delta
2002 -6.10% -6.17% 0.07%
2003 54.00% 55.82% -1.82%
2004 27.90% 25.55% 2.35%
2005 35.10% 34.00% 1.10%
2006 33.10% 32.17% 0.93%
2007 39.70% 39.39% 0.31%
2008 -52.90% -53.33% 0.43%
2009 82.60% 78.51% 4.09%
2010 19.80% 18.88% 0.92%
2011 -19.00% -18.42% -0.58%
Total 387.75% 366.14% 21.61%

Comparing 10-year Annual Returns of Emerging Market Indexes

One of the reasons for the substantial return differential in some years could probably be attributed to the classification of South Korea, which has a 15.4% weighting in the MSCI Emerging Markets Index as a developed country in the FTSE indexes. Therefore, the country weightings of other emerging markets in the MSCI Emerging Markets Index are somewhat different from the FTSE Emerging Index.

Country FTSE Emerging Index MSCI EM Index
China 16.72% 17.30%
South Korea   15.40%
Brazil 16.09% 13.15%
Taiwan 13.23% 10.95%
South Africa 10.56% 8.01%

Apart from the country weightings, the two emerging market indexes look fairly similar. This might explain the roughly similar risk-reward profile in the annual returns.

FTSE Emerging Index MSCI EM Index
No. of stocks 793 820
Total Market Cap $3.3 Trillion $3.4 Trillion
Average Market Cap $4.2 Billion $4.1 Billion
Median Market Cap $1.8 Billion $2.0 Billion

In future posts, we’ll take a look at the impact of the benchmark change on the Developed Market ETF and the US Total Stock Market ETF.