Canadian Capitalist » ETFs

Sector Breakdown of Diversified Portfolios

Canadian Capitalist — Wed, 16 May 2012 03:25:07 +0000

In a recent column, The Globe & Mail’s Rob Carrick (see Beware the limitations of buying the index, May 11, 2012) pointed out that investing in just the TSX Composite index might leave an investor with an unbalanced portfolio because of the index’s concentration in just three sectors: financials, energy and materials. The criticism is a valid one because, as you can see from the chart below, resource companies make up more than half the index and financials make up another one-third of the index. (As an aside, the sector breakdown of the S&P/TSX 60 index, which is tracked by the iShares S&P/TSX 60 ETF – TSX: XIU is pretty much the same as the broader Composite index).

This limitation of the TSX Composite Index is one reason why passive investors diversify their portfolios globally. The US Total Stock Market, for instance, offers much better diversification. The three dominant sectors in the Canadian market make up less than a third of the US stock market. The US stock market also offers exposure to sectors such as Information Technology, Healthcare and Consumer goods that have a much smaller representation in the Canadian index.

The MSCI EAFE Index which provides exposure to developed stock markets in Europe and the Pacific region is also well diversified across sectors. Financials and resources make up just 40 percent and the index has significant allocation to stocks representing Consumer goods, Utilities and Telecommunication services.

A globally diversified index portfolio such as the Sleepy Portfolio, which is split between Canadian, US, EAFE and Emerging Markets has a much better balance between sectors when compared to the Canadian stock market. The allocation to financials and resources drops to less than half the portfolio compared to three-quarters for the Canadian-market only index investor. And the allocation to sectors such as Consumer goods, Information Technology and Healthcare is also boosted substantially.

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What is iShares Planning After Acquiring Claymore

Canadian Capitalist — Thu, 03 May 2012 01:16:35 +0000

Recently, I had a chance to chat with Mary Anne Wiley, head of BlackRock Canada on what the 800 pound Gorilla in the ETF marketplace plans to do after the blockbuster acquisition of the #2 player Claymore Investments was recently finalized. After the acquisition closed, iShares rebranded all Claymore products (ticker symbols remained the same) but apart from that the only changes have been some minor adjustments. Here’s what I learnt:

I started off by asking why the Claymore Inverse 10 Year Government Bond ETF (CIB) was terminated and whether it presages any more fund closures. Ms. Wiley said that the decision was made because CIB was not consistent with the iShares brand since it was most effective for short-term holding periods and also had no strong market appeal.
iShares plans on maintaining the lineup of Research Affiliates Fundamental Index (RAFI) ETFs and laddered fixed-income ETFs both of which are very popular among individual investors. It appears that laddered ETFs make it easier to introduce the concept of low-cost fixed-income investing to retail investors compared to capitalization-weighted products, which are more popular among institutional investors.
Dividend Reinvestment Plans (DRIPs), Share Purchase Plans (SPPs) and Pre-Authorized Contribution Plans (PACCs) will be maintained for the Claymore ETFs.
DRIPs will be rolled out to all iShares products later this year. Since, many discount brokers already offer synthetic DRIPs on most ETFs, many investors already have the ability to reinvest dividends.
The advisor class ETFs which are sold through advisors and have an extra fee tacked on top to compensate for financial advice will be maintained for existing products.
iShares plans to roll out advisor class ETFs to the other products in its lineup.

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Performance of the Horizons Enhanced Income Equity ETF (HEX)

Canadian Capitalist — Tue, 10 Apr 2012 02:43:03 +0000

Horizons launched a whole slew of covered call ETFs last year of which the Horizons Enhanced Income Equity ETF (HEX) turned out to be the most popular. Enticed by the initial yield of about 20%, investors purchased as much as $247 million worth of HEX last year. The ETF invests in an equally-weighted portfolio of the largest 30 Canadian stocks and aims to generate monthly income by writing out-of-the-money covered calls on its stock holdings.

It appears that many investors had (just like they did with the BMO Covered Call Canadian Banks ETF) hoped that the juicy distributions will translate into higher total returns compared to a plain vanilla product like the iShares S&P/TSX 60 Index ETF (XIU). Now that HEX has a 1 year track record, let’s compare its performance with that of XIU:

Total Returns for the 1-year period ending March 31, 2012
Horizons Enhanced Income Equity ETF (HEX): -11.50%
iShares S&P/TSX 60 Index ETF (XIU): -10.32%

Now, let’s compare the income generated by the two ETFs as a percentage of starting NAV:

Income generated for the 1-year period ending March 31, 2012
Horizons Enhanced Income Equity ETF (HEX): 13.34%
iShares S&P/TSX 60 Index ETF (XIU): 2.25%

and the change in price level (assuming distributions are not reinvested):

Horizons Enhanced Income Equity ETF (HEX): -24.55%
iShares S&P/TSX 60 Index ETF (XIU): -12.62%

It is too early to draw definitive conclusions but it is interesting to note that HEX has slightly underperformed XIU on a pre-tax basis over the past year. However we can draw one conclusion: it is important to look beyond just the current distributions in evaluating an investment. A product with higher current income may not necessarily be the one that turns out to have higher total returns.

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A look at the Performance of the BMO Covered Call Canadian Banks ETF (ZWB)

Canadian Capitalist — Tue, 21 Feb 2012 03:17:32 +0000

BMO launched its Covered Call Canadian Banks ETF (TSX: ZWB) in January 2011. The ETF immediately started attracting investor attraction. Investors were mesmerized by the initial annualized yield of 10% and piled money into the fund: among ETFs launched in 2011, ZWB ranked first by Assets under Management by a wide margin. Interestingly, the second most popular among ETFs launched in 2011 is another covered call product: the Horizons Enhanced Income Equity ETF (TSX: HEX). Investors have clearly developed a preference for income products.

It appears that many investors thought (or at least hoped) the higher yield from ZWB compared to a plain vanilla product like the BMO S&P/TSX Equal Weight Banks Index ETF (TSX: ZEB) would translate into higher total returns. Now that ZWB has a 1 year track record under its belt, we can analyze how ZWB’s returns stacks up against ZEB’s.

Performance for the 1-year period ending Jan. 31, 2012
BMO Covered Call Canadian Banks ETF (ZWB): 2.84%
BMO S&P/TSX Equal Weight Banks Index ETF (ZEB): 3.59%

If we look at the income generated by these two ETFs as a percentage of starting NAV, we get:

Income generated for the 1-year period ending Jan. 31, 2012
BMO Covered Call Canadian Banks ETF (ZWB): 9.2%
BMO S&P/TSX Equal Weight Banks Index ETF (ZEB): 3.5%

In other words, though an investor earned a significantly higher current income with ZWB, she would have earned lower total returns compared to an investment in ZEB over the past year. Also, the income an investor receives from ZWB has also been dropping: the current annualized yield is 7.25%. Granted, a one year time frame is too short to make a fair comparison of ZWB and ZEB but the early results are not promising.

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iShares + Claymore is not good for Clients

Canadian Capitalist — Mon, 30 Jan 2012 02:00:15 +0000

Recently, BlackRock which offers 48 ETFs in Canada under the iShares label announced that it will be acquiring Claymore Canada, a vendor of 34 exchange-traded funds. The press release accompanying the announcement said that the transaction enhances BlackRock’s ability to “deliver excellence in innovation, quality and choice”.

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.

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Performance of the Currency-Neutral MSCI EAFE Index Fund

Canadian Capitalist — Thu, 12 Jan 2012 07:30:10 +0000

[Note: This post was originally published on January 6, 2010. I've updated it with the data for the past two years on the performance of the iShares MSCI EAFE CAD-Hedged Index Fund (TSX: XIN) relative to MSCI EAFE local currency returns. Bottom line: Though the performance lag of the past two years was slight, the annualized lag for the past six years is still significant due to the large performance drag observed in 2009.]

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.

Year	Local Currency	XIN	Difference
2011	-12.15%	-12.71%	0.56%
2010	4.82%	4.59%	0.23%
2009	24.72%	18.11%	6.61%
2008	-40.27%	-40.58%	0.31%
2007	3.54%	1.96%	1.58%
2006	16.46%	16.75%	-0.29%

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.

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iShares DEX Floating Rate Note ETF (TSX: XFR)

Canadian Capitalist — Thu, 15 Dec 2011 16:37:36 +0000

[The top bid in the Bloggers for Charity initiative is $400 by Straight Talk Investing's Dr. Dale Rathgeber. The deadline for sending in your bids is tomorrow, so if you want to outbid Dr. Dale, you may want to hurry and contact me directly.]

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.

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Bid-Ask Spreads of New Vanguard ETFs

Canadian Capitalist — Tue, 06 Dec 2011 16:23:20 +0000

[A quick update on where the bidding stands in the Bloggers for Charity auction. The top bid so far is $288.88 by The Cynical Investor. If you'd like to make a bid, you may want to hurry. Bidding will close on December 16, 2011.]

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.

ETF	Ticker	Bid	Ask	Spread in bps
Vanguard MSCI Canada ETF	VCE	24.65	24.70	20.2
Vanguard Canadian Aggregate Bond ETF	VAB	25.02	25.07	19.9
Vanguard Canadian Short-Term Bond ETF	VSB	24.95	25.02	28.0
Vanguard MSCI US Broad Market ETF	VUS	25.16	25.19	11.9
Vanguard MSCI EAFE ETF	VEF	25.03	25.07	16.0
Vanguard MSCI Emerging Markets ETF	VEE	24.68	24.71	12.1
iShares S&P/TSX 60 ETF	XIU	17.21	17.22	5.8
iShares DEX Universe Bond ETF	XBB	31.17	31.18	3.2
iShares DEX Short-Term Bond ETF	XSB	29.21	29.22	3.4

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.

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Analyzing ETF Liquidity

Canadian Capitalist — Mon, 21 Nov 2011 05:44:22 +0000

In a recent post, Thicken My Wallet argued that even though some ETFs may be cheaper, they are thinly traded which means that investors are taking on liquidity risk — the risk that a security cannot be quickly converted to cash. Here are the trading volumes of the Canadian dividend ETFs that were examined in the post:

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.

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Should you switch to Vanguard Canada ETFs?

Canadian Capitalist — Tue, 15 Nov 2011 03:23:14 +0000

Last week, Vanguard Canada announced the management fees and ticker symbols for its initial line-up of six Exchange-Traded Funds (ETFs). Staying true to its low-cost philosophy, Vanguard priced the ETFs cheaper than existing comparable products. While I’m very excited about the lower fees charged by Vanguard ETFs I think that any decision to switch out of existing ETFs should be made on a case-by-case basis. For instance, the management fee charged by the Vanguard MSCI Canada Index ETF (TSX: VCE) is about 6 basis points or so less than the iShares S&P/TSX 60 ETF (TSX: XIU). As Michael James pointed out in a recent post, if you own $10,000 worth of XIU, switching to VCE will save you just $6 per year. For investors paying $30 per trade, the tiny savings may not be worth the bother.

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.

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