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moneysense.ca, 14/07/10
A Tour of ETFs: Horizon AlphaPro Equal Weight 60 ETF (HEW)
Horizon’s AlphaPro and BetaPro ETF products have hitherto had little appeal to the long-term, buy-and-hold passive investor crowd. But, the introduction of the Horizon AlphaPro S&P/TSX 60 Equal Weight Index ETF (TSX: HEW) that tracks the S&P/TSX 60 Equal Weight Index (EWI) may change that. Unlike the more widely-known S&P/TSX 60 Index, which weights the constituent securities based on their market capitalization, the S&P/TSX 60 EWI gives equal weighting to each of the 60 stocks in the index. Therefore, HEW competes with the very popular 900-pound Gorilla in the ETF space — the iShares S&P/TSX 60 Index Fund (TSX: XIU). Let’s take a look at how HEW stacks up against XIU.
Better Diversified…
- HEW eliminates the potential problem of XIU having outsized exposure to a single stock. XIU’s top 10 holdings currently make up 45.1% of the index. That’s not as bad as Nortel alone making up more than 30% of XIU’s value around 2000 but today, four banks alone account for 22% of XIU. In HEW, on the other hand, any one stock accounts for just 1.66% of the index.
- HEW is better diversified than XIU. XIU has a 78.4% weighting to just three sectors — financials, energy and materials. HEW’s weighting to these three sectors is much less at 64.1%. The equal weight index has a higher allocation to Consumer Discretionary, Consumer Staples and Utilities.
… but with higher costs and higher turnover…
- More expensive. HEW’s Management Fee is 0.5% plus operating expenses compared to a MER of just 0.17% for XIU.
- HEW will experience more turnover since the portfolio will be rebalanced to equal weighting every quarter. XIU, on the other hand, is rebalanced only when the underlying index changes. Therefore, HEW will likely incur a higher tax hit than XIU.
- Standard & Poor’s own (admittedly, rather limited) data suggests that there is little to choose between the traditional and equal-weighted flavours of the index. While the equal-weighted index sported slightly better returns and lower risk in the recent past, the slight advantage could be easily eroded by higher fees and higher turnover.
- As HEW was launched just today, it is hard to judge how well the ETF will track the underlying S&P/TSX 60 Equal-Weighted Index in the future. The prospectus (available here on SEDAR) mentions that HEW will not track the S&P/TSX 60 EWI perfectly but it would be interesting to see how much higher tracking error is in light of higher transaction costs, taxes and expenses.
Bottomline
Though HEW is an interesting and unique addition to the Canadian ETF landscape, I don’t see a compelling reason to rush to embrace it. Since I hold XIU in our taxable accounts, switching will involve taking a significant capital gains hit. Investors who don’t have that problem may also want to wait until HEW has a established track record that shows that the benefits outweigh the expected hit from higher fees, higher turnover and higher expenses.
moneysense.ca, 14/07/10
I agree with your conclusion. Any MER above 0.3% makes me hesitate.
“available here on SEDAR”. Hi CC, the link is missing.
All my CAD equity is in XIC and I don’t see this changing anytime soon.
@Michael: Agree. There are positives to an equal weight index but at this moment, I’m going to stick with XIU.
@GSP: I’ve added the link. Thanks for pointing it out.
CC- are you saying you face unrealized “significant capital gains” in your XIU position? Or are you simply stating that capital gains taxes factor into the decision in taxable accounts?
The management fee (0.5%) is way too high. What kind of “management” is there? The index is available and it’s just a matter of copying it. With operating expenses, taxes, etc I guess the total fees will be around 1%. Useless for me like all Horizon products. I’ll stick with XIU. If the fees were comparable, I would have put “new money” into it.
By the way, aren’t all ETF’s required to state their MER’s and not just their ME’s? I think we need new regulations in this area. Very hard to compare between funds.
@Sean: My guess is that HEW will cost about 1% in a taxable account as well. XIU’s tracking error has been very good — an annualized 0.19% since inception. That’s very very good, considering the MER is 0.17%.
@Rob: Both. I switched my individual stock holdings to XIU last year. Since then, the markets are up sharply and I have quite a bit of unrealized capital gains. So, it is a consideration for me. I suppose capital gains taxes will factor into other investors in the same situation.
[...] Canadian Capitalist reviews a new Canadian equal-weighted index ETF. [...]
Just to play the devil’s advocate, Bogle, Malkiel and Sharp appear to say that non-market cap weights in an index represent an attempt to tilt toward value and small cap stocks, and that proponents incorrectly assume the historical premiums on these sub-sectors will persist into the future (investors tend to arbitrage away excess profits once detected). So, over time, an investor in a non-market cap index could end up earning the market return less the fees — and since the fees are greater than fees on maket-cap indexes, lesser performance is entailed.
[...] Canadian Capitalist reviews the Horizon AlphaPro S&P/TSX 60 Equal Weight Index ETF [...]
Joel Greenblatt’s latest book, “Big Secret” claims an excess return of 1-2% for equal weighted indices. So that would more than compensate for the higher MER.
But there’s still the problem of increased transaction costs from constant rebalancing and the tax issue.
Still…the Rydex S&P500 Equal Weight index performance in the US has been impressive. There is more and more buzz about equal weighting these days. Imagine what will happen to the price of the less liquid, smaller-cap shares once everyone joins this party. Those who get in early could make a bundle!