According to the Canadian ETF Association, iShares is already the dominant player in the ETF sector with a market share of 67%. Claymore currently occupies the #2 slot with a market share of 15.5%. When the deal is consummated (unfortunately, it is likely a question of “when”, not “if” the deal will be approved, because BlackRock can probably successfully argue that its market share of the overall fund business is fairly small), BlackRock’s market share will become even more dominant at 82.5%. Or look at it this way: iShares currently has 13 out of the 20 largest ETFs by assets under management. After acquiring Claymore, BlackRock will have 18 out of the top 20 ETFs.

It is true that other ETF vendors are competing strongly. In 2011, BMO was virtually tied with iShares in net ETF creations at 33%. Claymore occupied the #3 spot with 20%. Combining iShares with Claymore (Jon Chevreau cleverly dubbed the combination “ClayShares”) would mean BlackRock would have more than 50% of the 2011 ETF sales to go along with its dominant position in the ETF landscape. It is hard to see how the creation of a virtual monopoly will deliver innovation and choice for ETF investors.

Related Reading:

• State of the Canadian ETF Industry Q3-2011
• iShares ETFs becoming more expensive
• Wrap ETFs from Claymore
• More New ETFs
• Scotia iTrade’s Commission-Free ETFs: A good deal for some investors

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I’ve looked at the tracking error of S&P 500 currency-neutral funds in past years but the tracking errors in the iShares CDN MSCI EAFE 100% Hedged to CAD Dollars Index (TSX: XIN) remained a mystery because I didn’t have the annual return data for the MSCI EAFE Index* in local currency. XIN holds the iShares MSCI EAFE Index fund (NYSE Arca: EFA) and hedges the foreign currency exposure that EFA’s holdings are denominated in, so that the returns of stocks will not be impacted by changes in the exchange rates between Canadian Dollars and Yen, Pound, Euros and other currencies. (As an aside note that even though EFA trades in the US, Canadian investors holding EFA are not affected by fluctuations in the exchange rate between the CAD and USD but are exposed to the fluctuations between the CAD and a basket of currencies such as Yen, Pound, Euros etc.).

Fortunately, MSCI Barra reports the returns of MSCI EAFE and other MSCI indices in local currencies on their website. Armed with that data, we can look at how well XIN tracks the MSCI EAFE in local currency terms. The following table shows the annual total returns of MSCI EAFE Index in its local currencies (column 2) with XIN (column 3). The results are consistent with our earlier analysis of the tracking error of XSP. XIN shows an annualized tracking error of 1.30%, which is lower than the tracking error shown by XSP but still wide enough to suggest that currency hedging is highly likely to be unprofitable.

 
When a Canadian investor holds a foreign investment directly, they take on the risk that currency fluctuations will affect their returns. Sometimes, the fluctuations will be in the investor’s favour. Other times, as Canadian investors directly holding US securities can readily attest to, fluctuations will hurt returns. Canadian investors in the iShares MSCI EAFE Index Fund (EFA) would have experienced a significant boost from the currency effect. In local currency terms, the MSCI EAFE Index lost 17.3% over the 2006 to 2011 period. Since investors in XIN trailed the index by an annualized 1.30%, XIN’s loss over the same six year period is 23.73%. However, a Canadian investor holding EFA directly would have a loss of 13.91% over the same time period.

The verdict on currency-hedging then (based on an admittedly short history of just 6 years) is clear: Long-term investors are highly unlikely to profit from hedging their currency exposure because currency effects have to overcome significantly large tracking errors simply to break even. When currency effects are negative (as it was the case of the CAD/USD and US markets over 2006 to 2011), currency-hedging still did not show a profit due to tracking error. With positive currency effects (as was the case with CAD/basket and EAFE index over 2006 to 2011), currency-hedged investors are trailing even more because investors did not get the currency boost and paid for their hedging efforts through tracking error.

* – MSCI EAFE Index tracks stock markets in Europe, Australasia and Far East and holds securities that trade in countries such as Japan, the UK and Germany.

Related Reading:

• The Costs of Currency Hedging
• A Tour of ETFs: iShares MSCI EAFE Index Fund
• Comparing Currency-Hedged and Unhedged Holdings
• Flavours of an Index Fund
• Performance of Currency-Neutral S&P 500 Index Funds

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iShares recently introduced a Floating Rate Note ETF (Factsheet, Prospectus) that mostly holds federal and provincial bonds that pay a variable coupon that is referenced to a specified market interest rate and adjusted regularly. iShares says that the rationale for owning floating-rate securities is to minimize losses in the bond portion of the portfolio in a rising interest rate environment. The ETF’s management fee is 0.20% and iShares will be waiving the management fees for an introductory period.

Traditional fixed income securities typically decrease in value when interest rates rise and increase in value when interest rates decrease. Floating-rate bonds, on the other hand, are less sensitive to interest rate fluctuations but the income stream from floating-rate securities will fluctuate based on prevailing interest rates. Currently, XFR sports an yield-to-maturity of 1.46% and the duration is just 0.13 years (duration is a measure of the sensitivity of a fixed-income security to interest rate changes). In other words, XFR offers cash like exposure.

Given XFR’s cash-like risk/return profile, it seems to me that investors have better options. High Interest savings accounts offered through discount brokers currently offer an yield of 1.25%, which is pretty much exactly the same as XFR’s yield of 1.46% less the management fee of 0.20%. However, unlike an ETF, the high interest savings accounts can be bought and sold without incurring a trading commission.

Related Reading:

• A Tour of ETFs: iShares Bond ETFs (XSB, XBB)
• Mortgage Rates: Fixed or Floating
• Short-Term versus Long-Term Bonds
• Claymore 1-10 Year Laddered Government & Corporate Bond ETFs
• Natural Gas: Fixed or Floating

iShares DEX Floating Rate Note ETF (TSX: XFR) is brought to you by Canadian Capitalist -- Helping you to invest & prosper.

Vanguard’s initial line up of six exchange-traded funds (ETFs) started trading on the TSX today. Since I am interested in switching one or two of our current holdings over to Vanguard, I was curious to find out if the bid-ask spreads of the newly-listed ETFs are reasonable. Just to refresh your memory, bid-ask spread refers to the difference between the price you’ll pay for buying a security and the price you’ll pay get selling it. For example, you’ll pay $24.68 to buy Vanguard MSCI Canada Index ETF (TSX: VCE) and $24.64 to sell it. Therefore, the bid-ask spread is 4 cents.

In the table above, you’ll find bid-ask spreads for Vanguard and comparable iShares ETFs I pulled up at 10:45 EST on December 6, 2011. As you can tell from the table, Vanguard’s new ETFs currently have a much higher spread than equivalent iShares ETFs. If you recall, VCE is about 6 basis points cheaper than XIU. But if you decide to switch today from XIU to VCE, you’ll incur a cost of 13 basis points (3 basis points in selling XIU and 10 basis points in buying VCE), which likely means it is not worth your while. I was interested in replacing XSB with VSB but the steep spread of 16 basis points means that I’m inclined to wait and watch on the sidelines.

Update (December 7, 2011, 10:10 AM EST): Checking the quotes now shows spreads ranging from 1 cent for VSB to 4 cents for VCE. Since the VSB spread is so narrow, it would cost an investor just 4 basis points to switch from XSB to VSB. Obviously, a reasonable spread such as this makes switching to Vanguard worthwhile. However, note that you should consider the tax impact of any switch in a non-registered account.

Related Reading:

• Should you switch to Vanguard Canada ETFs?
• Vanguard announces ETF pricing and ticker symbols
• Vanguard to Introduce Six New ETFs
• Switching from Index Mutual Funds to ETFs
• More ETFs from BMO

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iShares Dow Jones Canada Select Dividend Index ETF (TSX: XDV): 52,719
Claymore S&P/TSX Canadian Dividend ETF (TSX: CDZ): 56,752
iShares S&P/TSX Equity Income Index ETF (TSX: XEI): 8,234
BMO Canadian Dividend ETF (TSX: ZDV): 1,200
PowerShares Canadian Dividend Index ETF (TSX: PDC): 6,100

Investors should note that unlike a stock, the trading volume an ETF is not a good indication of its liquidity. Instead the liquidity of an ETF depends on the liquidity of the securities that make up an ETF. In Thicken My Wallet’s example of Canadian Dividend ETFs, the underlying securities — dividend paying Canadian stocks — are very liquid securities and the spread and bid/ask sizes reflect this. Here are the bid/asks and sizes of the same Canadian dividend ETFs that I looked up on November 18, 2011:

XDV Bid/Ask 19.63/19.64
Bid Size/Ask Size 1/377

CDZ Bid/Ask 20.91/20.95
Bid Size/Ask Size 233/2

XEI Bid/Ask 18.54/18.56
Bid Size/Ask Size 1/298

ZDV Bid/Ask 14.92/14.95
Bid Size/Ask Size 100/199

PDC Bid/Ask 18.19/18.23
Bid Size/Ask Size 5/105

Though the volume of ZDV is quite low, investors should have no trouble buying or selling the ETF. The bid size is 100, which means that an investor will be able to sell 10,000 shares at $14.92 even though the total volume of ZDV on the same day was only 3,295. Also, an investor will be able to buy 19,900 shares at $14.95.

Related Reading:

• Where is the Leak?
• XDV versus CDZ
• Why do ETF Investors do worse than Index Mutual Fund Investors?
• Does the BMO Canadian Dividend ETF (TSX: ZDV) change the dividend ETF landscape?
• Tracking Error in Emerging Markets ETFs

Analyzing ETF Liquidity is brought to you by Canadian Capitalist -- Helping you to invest & prosper.

So, how do you decide whether you want to switch from an existing ETF into a new product? Here are some factors to consider:

1. Do you hold the investment in a registered account or a taxable account? In taxable accounts, if the adjusted cost basis of your investment is less than its current value, you may be liable for taxes on capital gains. It probably won’t make much sense to pay capital gains to save a few basis points in management fees. But you could decide to channel future savings into the lower cost ETFs and if markets take a steep dive, you could switch out of current holdings and if things get really bad, you may even be able to trigger capital losses.

2. In registered accounts, the math is straightforward. Let’s say that if you save $100 per year in fees, it will be worth your while to switch. The Vanguard Short-Term Bond ETF (TSX: VSB) costs 10 basis points less than the iShares DEX Short-Term Bond ETF (TSX: XSB). If you hold $100,000 worth of XSB in a registered account, switching to VSB will save you about $100 per year. However, keep in mind that you’ll be paying two trading commissions and bid-ask spreads when selling one ETF and buying another. You can knock down the number of trades to one by switching during a rebalancing event but switching will still cost you one trading commission plus bid-ask spreads. If it will take many years for the savings in management fees to make up for the upfront trading costs, it may not be worth your while to switch ETFs.

3. Investors should pay close attention to the bid-ask spreads of the new Vanguard ETFs. Even if volume is low, there may be enough bids and asks to execute your trades at a tight spread. In other words, it is tight bid-ask spreads, not volume that matters when trading ETFs.

4. If you do decide to switch to Vanguard ETFs upon launch, you are making a bit of a leap of faith that Vanguard will be able to keep tracking errors low. I think Vanguard ETFs will be successful in tracking their indexes closely but you are not paying too much in extra fees if you do decide to wait-and-watch.

Related Reading:

• Bid-Ask Spreads of New Vanguard ETFs
• More ETFs from BMO
• Wash Trades Save You Money
• Vanguard announces ETF pricing and ticker symbols
• A Peek at Vanguard’s Australian ETFs

Should you switch to Vanguard Canada ETFs? is brought to you by Canadian Capitalist -- Helping you to invest & prosper.

1. The Vanguard MSCI Canada Index ETF, which tracks the MSCI Canada Index will charge a management fee of 0.09%, which is cheaper than iShares S&P/TSX 60 Index ETF (TSX:XIU) management fee of 0.15%. The ticker symbol is VCE. The ETF will hold all or substantially all of the underlying stocks that make up the index.

2. The Vanguard Canadian Aggregate Bond Index ETF will track an index of Canadian government and investment grade corporate bonds. The management fee is 0.20% and the ticker symbol is VAB. This ETF is cheaper than the comparable iShares DEX Universe Bond Index ETF (TSX: XBB), which has a management fee of 0.30%.

3. The Vanguard Canadian Short-Term Bond ETF will track an index of Canadian government and investment grade corporate bonds with maturities ranging from 1 to 5 years. The management fee is 0.15% and the ticker symbol is VSB. The ETF is also cheaper than the comparable iShares DEX Short Term Bond Index ETF (TSX: XSB), which has a management fee of 0.25%. Both bond ETFs will employ a sampling methodology to track the index.

4. The Vanguard MSCI U.S. Broad Market (CAD-Hedged) ETF will primarily hold the Vanguard Total Stock Market ETF (VTI) and hedge the foreign currency exposure. The management fee is 0.15% and the ticker symbol is VUS.

5. The Vanguard MSCI EAFE (CAD-Hedged) ETF will primarily hold the Vanguard MSCI EAFE ETF (VEA) and hedge the foreign currency exposure of VEA holdings. The management fee is 0.37% and the ticker symbol is VEF. The ETF is cheaper than the iShares MSCI EAFE ETF’s (TSX: XIN) management fee of 0.50%.

6. The Vanguard MSCI Emerging Markets ETF will primarily hold the Vanguard MSCI Emerging Markets ETF (VWO). The management fee is 0.49% and the ticker symbol is VEE. The ETF is considerably cheaper than two alternative products available today: the iShares
MSCI Emerging Markets ETF (TSX: XEM, management fee: 0.82%) and the Claymore Broad Emerging Markets ETF (TSX: CWO, management fee: 0.65%). Just like the other foreign equity ETFs the management fee listed is inclusive of the management fee charged by VWO.

I think these ETFs will attract considerable attention from investors. I personally will be replacing the iShares DEX Short Term Bond ETF (TSX: XSB) with VSB (provided bid-ask spreads are reasonable). I currently hold XIU in a taxable account and it has unrealized capital gains, so switching to VCE is not immediately practical. However, I think VCE will be a strong candidate for future additions to the Canadian Equity portion of the portfolio and if markets take a tumble, switching out of XIU will also become an option. Investors who currently hold foreign equity ETFs such as XSP, XIN and CWO should take a closer look at the cheaper Vanguard alternatives.

Related Reading:

• Vanguard to Introduce Six New ETFs
• A Tour of ETFs: Vanguard Europe Pacific ETF
• A Tour of ETFs: iShares MSCI EAFE Index Fund
• A Tour of ETFs: Vanguard Emerging Markets ETF
• Bid-Ask Spreads of New Vanguard ETFs

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ZDV aims to undercut the two largest existing dividend ETFs – the iShares Dow Jones Canada Select Dividend ETF (TSX: XDV) and the Claymore S&P/TSX Canadian Dividend ETF (TSX: CDZ) by charging a management fee of 0.35%. In comparison, XDV charges 0.50% and CDZ charges 0.60%. iShares also has the S&P/TSX Equity Income ETF (TSX: XEI) in its line up. XEI’s management fee is 0.55%. XDV, CDZ, XEI and ZDV yield 4.08%, 3.12%*, 4.1% and 4.25% respectively.

So, which one to choose? Other than the fact that CDZ belongs in the bottom of the pack, it is not clear which of these ETFs will be a suitable holding. CDZ’s yield is far too low for a “dividend” ETF considering XIU yields 2.36%. It’s not easy making a choice between the other ETFs because the holdings are wildly different owing to the different stock selection criteria their respective indices employ. Worse, apart from XDV which keeps turnover low by making it difficult for a holding to drop out of the selection set, the other dividend ETFs will have high turnover. But XDV is not without its own set of flaws either. Financials make up more than half the holdings and the big banks alone account for more than a third of the fund.

XDV – okay MER, low turnover but high concentration in financials and banks.
CDZ – high MER, high turnover, low dividend yield.
ZDV – low MER, high turnover (?), new fund
XEI – high MER, high turnover, well diversified, relatively new fund, low volume.

* – Originally, CDZ’s yield was reported as 2.78%. It was incorrect. Thanks to reader DM for pointing it out.

Related Reading:

• New Dividend ETF
• XDV versus CDZ
• New PowerShares Dividend ETFs
• Horizon AlphaPro Covered Call ETFs: Enhanced Equity ETF (HEX) and more…
• A Tour of ETFs: Horizon AlphaPro Equal Weight 60 ETF (HEW)

Does the BMO Canadian Dividend ETF (TSX: ZDV) change the dividend ETF landscape? is brought to you by Canadian Capitalist -- Helping you to invest & prosper.

The Claymore 1-10 Year Laddered Government Bond ETF (TSX: CLG) holds 53 bonds with maturities ranging from 1 year to 10 years issued by the Federal and Provincial Goverments. The laddering strategy is implemented by reinvesting maturing bonds in a new 10 year bond. The MER of the ETF is 0.17%, the yield-to-maturity is 1.82% and the duration is 4.36 years.

The Claymore 1-10 Year Laddered Corporate Bond ETF (TSX: CBH) holds 56 investment grade corporate bonds with maturities ranging from 1 year to 10 years. The MER of the ETF is 0.28%, the yield to maturity is slightly higher at 2.79% and the duration is 4.14 years.

One or both these ETFs will be of interest to investors looking for broad exposure to the bond market. The duration (a measure of the sensitivity of bond prices to interest rate changes) of both these ETFs is higher than the iShares DEX Short Term Bond ETF (TSX: XSB, MER: 0.27%, YTM: 1.68%, Duration: 2.61) and lower than the iShares DEX Universe Bond ETF (TSX: XBB, MER: 0.32%, YTM: 2.57%, Duration: 6.43). But the MERs are quite a bit lower than both iShares ETFs and you can lower the cost of owning even further if you can buy these ETFs without a commission.

A couple of points to note: despite the name, the Claymore Laddered Bond ETFs are not quite the same as a bond ladder an investor could construct herself because unlike a ladder, the investor has no control over reinvesting maturing bonds in the ETF. Therefore the ETFs are only suitable holdings for long-term investors who are will be reinvesting maturing bonds indefinitely. Also note that the cash yield of these ETFs is quite a bit higher than the YTM, which all things being equal implies that the ETF will experience a drop in the price level over time.

Related Reading:

• Claymore 1-5 Yr Laddered Government Bond ETF
• New ETFs From PowerShares
• More Exchange-Traded Funds from BMO
• A Tour of ETFs: iShares Bond ETFs (XSB, XBB)
• RBC Corporate Bond ETFs

Claymore 1-10 Year Laddered Government & Corporate Bond ETFs is brought to you by Canadian Capitalist -- Helping you to invest & prosper.

The predecessor Horizons AlphaPro Gartman Fund (TSX: HAG.UN) was offered to investors at $10 per share and launched with much fanfare on March 26, 2009. Mr. Gartman even provided a statement in the fund prospectus:

Each investment is made with specific risk management parameters in place. The goal is to enhance profits by quickly and, as we can, repeatedly adding to successful investments and by promptly and decisively reducing exposure to losing investments. We take no pleasure in being right or wrong, only in positive absolute returns. We are, as we like to say, “investment mercenaries” seeking to fight on the winning side and risking little real or mental capital in fighting losing battles. We are in the business of buying assets high and selling higher believing that strength begets strength and weakness begets weakness. While it is critical to understand the macro-economic fundamentals that drive the market, it is equally critical to understand the technical indicators, investing bullishly or bearishly only when these indicators support such action, always cognizant of Lord Keynes warning that “markets can remain illogical far longer than you or I can remain solvent.” As such, risk management is of primary importance. We are in the business of generating profits but always remain mindful of the critical importance of first and foremost protecting principal

So, what returns have investors in the ETF received for steep fees, furious trading and rather flowery statements? Not very much even though one would think that the Canadian T-bill rate isn’t all that high a hurdle to clear. The ETF closed today at $7.83 and no distributions were made in the past. Now let’s see: a fund launched pretty much at the bottom of one of the biggest bear markets ever manages to lose 21% of its capital in the roaring bull market that followed. If you want to keep score, the TSX Composite opened at 8,939 on March 26, 2009. It closed today at 12,053 for a gain of 34% not including dividends.

There is a bright side to the story: investors seem to have clued in to the effectiveness of Mr. Gartman’s trading strategies. The fund, which raised $55 million at launch, has seen a steady stream of redemptions and now has just under $12 million in assets.

PS: I shamelessly copied the title of today’s post from Larry Swedroe who frequently asks if some actively managed fund or other adds value on his blog. I can’t think of a better headline.

Related Reading:

• Book Review: Your Money & Your Brain
• Stock Market Recovery: What to do now?
• The Selective Access Edge for Institutional Investors
• Financial Stability Board Warning on ETFs
• A Tour of ETFs: Claymore Broad Commodity ETF (CBR)

Does Horizons AlphaPro Gartman ETF (HAG) Add Value? is brought to you by Canadian Capitalist -- Helping you to invest & prosper.