Canadian Capitalist » Index Funds

Performance of Currency-Neutral S&P 500 Index Funds

Canadian Capitalist — Mon, 09 Jan 2012 01:30:44 +0000

[Note: The following post was originally published on Jan 3, 2010. I've now updated it with the latest returns for XSP and IVV. The bottom line is that the performance of currency-hedged funds still lags that of the local currency fund by a significant margin.]

Many investors would like to have exposure to US stocks in their portfolio even if they believe that the US dollar is in a secular decline against other major currencies. In theory, currency-neutral funds seem to offer the best of both worlds: exposure to one of the world’s most dynamic stock markets without the baggage of the risk of a depreciating currency. However, if you look at the (short) performance history of currency-neutral funds, a different reality emerges.

First, let’s compare the returns of the iShares CDN S&P 500 Hedged to Canadian Dollars Index Fund (TSX: XSP) with the iShares S&P 500 Index Fund (NYSE Arca: IVV) in US dollars. In the following table, the annual total returns of XSP are listed in Column 2 and the total returns of IVV in US dollars are listed in Column 3. The performance between the two funds is compared from 2006 because in 2005 and earlier years, XSP was a clone fund that used derivatives to skirt RRSP foreign content rules that were in place at that time. While XSP’s MER of 0.25% is just 16 basis points (0.16%) higher than IVV, the difference in performance (shown in Column 4) is much wider.

A Canadian investor who put $100 (Canadian) in XSP in 2006 would be left with just $99.27 at the end of 2011. A US investor who put $100 (US) in IVV, on the other hand, would be left with $114.03. In other words, the returns in XSP trailed that of IVV by an annualized rate of 2.33%. A Canadian investor betting that the C$ would appreciate against the USD and opting XSP over holding IVV directly would have been right on the first count but made no money on the bet. The C$ appreciated at an annualized 2.20% against the USD but the tracking error of XSP wiped out all the gains and then some.

Year	XSP	IVV (in US$)	Difference
2011	1.07%	2.03%	0.96%
2010	13.47%	14.97%	1.50%
2009	22.95%	26.40%	3.45%
2008	-40.33%	-36.94%	3.39%
2007	3.23%	5.43%	2.20%
2006	14.30%	15.68%	1.38%

This pattern of the currency-neutral fund exhibiting significant tracking error can also be observed in the TD e-Series index funds. As you can see in the following table, the TD e-Series US Index Currency Neutral fund underperforms the TD e-Series US Index (US$) fund by an annualized 1.82%.

Year	TD US Index (CAD)	TD US Index – Currency Neutral	TD US Index (USD)	Difference
2011	4.10%	0.30%	1.50%	1.20%
2010	8.40%	12.60%	14.30%	1.70%
2009	6.70%	22.20%	25.70%	3.50%
2008	-21.70%	-39.00%	-37.40%	1.60%
2007	-11.10%	3.10%	4.90%	1.72%
2006	14.70%	14.00%	15.10%	1.10%

It is often asked why currency-hedged funds have exhibited such horrendous tracking errors. It turns out that the bulk of the blame can be attributed to the tendency of stocks and currencies to move in opposite directions (See post Why Currency-Hedged Funds have Large Tracking Errors).

So, what should investors do? If past performance is any indication and if investment performance is the only consideration, it appears that investors will likely be better off obtaining direct exposure to foreign equities without hedging away currency exposure. Owning foreign stocks directly has provided better returns in the past and it has done so with lower risk.

Related Reading:

Performance of Currency-Neutral S&P 500 Index Funds is brought to you by Canadian Capitalist -- Helping you to invest & prosper.

TD e-Series Accounts Not Very Hard to Set Up

Canadian Capitalist — Wed, 11 May 2011 02:55:35 +0000

As someone who has invested in TD e-Series Mutual Funds both through a brokerage account at TD Waterhouse and my kids’ mutual fund RESP accounts, I’m somewhat mystified by the flak these funds sometimes receive. In a recent column, Globe & Mail columnist Rob Carrick called TD e-Series Mutual Funds “well-loved but frustratingly elusive”. Investors are apparently frustrated because they can’t simply walk into a branch and plonk some cash into an e-series Mutual Fund.

While I admit that setting up a TD e-Series account is not the simplest process in the world, my experience with establishing these accounts was very smooth. All I had to do was follow the steps outlined in the TD e-Series Mutual Funds webpage. It was no more difficult than, say, opening new brokerage accounts. The process involved a visit to a local TD Canada Trust branch to open a RESP account and one mailed-in application to have the account converted into a TD e-Series account. Hardly onerous or complicated, if you ask me. Once the initial setup is done, it is smooth sailing thereafter: it takes only a few clicks of the mouse to contribute cash or rebalance the portfolio.

I did find that fund salespeople at the local TD Canada Trust branch are not well informed about the e-Series funds. If a client walks into a branch and asks to open an e-Series account, they are likely to be met with blank stares or attempts to place them in one of the more expensive funds in the TD Mutual Fund line-up. TD Canada Trust is positioning e-Series funds as a direct-to-investor, online-only mutual fund. DIY Investors can’t complain too much if a local branch knows how to sell a 2.13% MER fund but is unaware of the existence of a 0.32% MER index fund.

Related Reading:

TD e-Series Accounts Not Very Hard to Set Up is brought to you by Canadian Capitalist -- Helping you to invest & prosper.

Tracking error in TD e-Series Funds, Part 2

Canadian Capitalist — Tue, 16 Mar 2010 04:06:20 +0000

In Part 1 of this series, we examined the tracking error exhibited by the TD e-Series Canadian Bond Index Fund and the Canadian Index Fund and found that both funds track their respective benchmarks fairly well. In today’s post, we’ll look at the tracking error in the TD e-Series US Index fund and the International Index Fund.

TD e-Series US Index (TDB902)

The TD e-Series US Index Fund tracks the S&P 500 in Canadian dollars and has a MER of 0.33%. Assuming the dividend yield of S&P 500 is 2%, the withholding tax can be expected to result in a further hit of 0.3% (15% withholding tax on a 2% dividend yield). The actual tracking error of TDB902 averages 0.57% over the 2004-09 period, which is fairly close to the expected tracking error of 0.63%. However, note that the tracking error fluctuates quite a bit around the average and in some years, the fund’s returns are higher than the index.

Year	S&P 500 (in CAD)	TDB902	Difference
2004	2.8%	2.2%	0.6%
2005	1.5%	1.7%	-0.2%
2006	16.0%	14.7%	1.1%
2007	-10.3%	-11.1%	0.9%
2008	-22.6%	-21.7%	-1.1%
2009	9.1%	6.7%	2.2%

TD e-Series International Index (TDB911)

TD e-Series International Index Fund tracks the MSCI EAFE Index in Canadian Dollars. It has a MER of 0.48% but its tracking error can be expected to be higher due to the drag from withholding taxes on dividends. In 2009, TDB911 trailed the index by 4.2% but in the previous year, it returned 3.1% more than the index. On average, TDB911 has trailed the index by 0.74% over the past five years.

Year	MSCI EAFE (in CAD)	TDB911	Difference
2004	11.9%	10.9%	0.89%
2005	10.3%	10.2%	0.09%
2006	27.1%	25.5%	1.26%
2007	-5.0%	-6.0%	1.05%
2008	-30.0%	-27.9%	-3.05%
2009	14.3%	9.5%	4.20%

Both the US Index Fund and the International Index Fund track the benchmarks fairly well over the five year period ending in 2009 but the annual returns can deviate quite a bit from the index. This is especially so for the international fund because TD Mutual Funds does not fully replicate the MSCI EAFE Index but instead uses a sampling technique to select a representative subset of stocks. ETFs such as the Vanguard Europe Pacific ETF (VEA) also employ statistical methods to sample the index. Sampling can sometimes result in quite large tracking errors in annual returns, especially in volatile markets like the ones we experienced in 2008 and 2009.

Bottom line

The tracking errors in TD e-Series Funds are not way out of line of what you’d expect when you take into account costs like MERs, withholding taxes, foreign exchange fluctuations and sampling errors. TD e-Series Funds remain a great choice for low-cost, diversified portfolios, especially when modest amounts are invested on a regular basis but the funds that track foreign stock markets can have large annual tracking errors (both positive and negative).

Related Reading:

Tracking error in TD e-Series Funds, Part 2 is brought to you by Canadian Capitalist -- Helping you to invest & prosper.

Tracking error in TD e-Series Funds, Part 1

Canadian Capitalist — Mon, 15 Mar 2010 04:20:10 +0000

TD e-Series funds are popular holdings in many low-cost portfolios because the funds’ MERs are among the lowest for index mutual funds in Canada. We too own TD e-Series funds in our kids’ RESP accounts because, as I noted in earlier posts, these mutual funds are ideal for relatively smaller portfolios. However, I’ve never paid much attention to the tracking error of e-Series funds even though how well a fund tracks its benchmark is an important criterion in picking an index fund. After a recent note from a reader, who noticed a large tracking error in the TD International Index Fund for 2009, I decided to examine the tracking error in e-Series funds.

TD e-Series Canadian Bond Index Fund (TDB909)

The TD e-Series Canadian Bond Index Fund, which tracks the DEX Universe Bond Index, is a popular pick for the fixed-income component of a portfolio. It sports a MER of 0.48% but it’s tracking error averages 0.62% over the 2004-2009 period.

Year	Bond Index	TDB909	Difference
2004	7.1%	6.5%	0.6%
2005	6.5%	5.7%	0.8%
2006	4.1%	3.6%	0.5%
2007	3.7%	3.2%	0.5%
2008	6.4%	5.7%	0.7%
2009	5.4%	4.6%	0.8%

TD e-Series Canadian Index Fund (TDB900)

The TD e-Series Canadian Index Fund has a MER of just 0.31%. The tracking error averages just 0.30% and the fund tracks the index fairly well as you can see from the table below.

Year	Canadian Index	TDB900	Difference
2004	14.5%	14.0%	0.44%
2005	24.1%	23.3%	0.64%
2006	17.3%	16.9%	0.34%
2007	9.8%	9.6%	0.18%
2008	-33.0%	-32.9%	-0.15%
2009	35.1%	34.6%	0.37%

Both TDB909 and TDB900 track their benchmarks reasonably well but the Canadian Bond Index does have a larger than expected tracking error. Tomorrow, we’ll take a look at the tracking error in TD e-Series US Index (TDB902) and the TD e-Series International Index (TDB911).

Note: Benchmark returns were obtained from the Libra Investments website.

Related Reading:

Tracking error in TD e-Series Funds, Part 1 is brought to you by Canadian Capitalist -- Helping you to invest & prosper.

Why do ETF Investors do worse than Index Mutual Fund Investors?

Canadian Capitalist — Tue, 23 Jun 2009 03:53:19 +0000

Jon Chevreau recently blogged (see John Bogle says investors getting killed by ETFs) on John Bogle’s analysis of returns experienced by investors in Exchange-Traded Funds (ETFs) and the results are not pretty: In 68 out of 79 ETFs, the returns experienced by investors lagged that of the ETFs themselves by an average of 4.5%. Bogle also found that investors in ETFs did much worse than investors in index mutual funds. In some categories such as large-cap stocks and small-cap stocks, the gap was particularly large — more than 7%. And the shortfall was as much as 12% in REITs! These results mirror that of the famed DALBAR study, which consistently finds mutual fund investors earning lower returns than the funds themselves (see Investors Behaving Badly).

I think the comparison of index mutual fund investors to those of ETFs is a bit simplistic. Unlike mutual funds, which are purchased by retail investors with the intention of holding for the long-term, the motivation for buying ETFs varies according to the type of investor. Some are passive investors who intend to hold ETFs in an indexed portfolio for the long-term. But most ETF buyers and sellers are traders who hope to profit from short-term movements. The popularity of ETFs with traders can be seen in the contrast in volume between Vanguard and iShares ETFs that track the same index. Despite charging less than half in fees, Vanguard ETFs such as the Emerging Markets ETF (VWO) and Europe Pacific ETF (VEA) have much lower trading volume than their corresponding iShares ETFs. Long-term investors would care more about the lower fees but traders would be primarily concerned with liquidity and low bid/ask spreads, not a MER difference of a few tenths of a basis point. Therefore, it shouldn’t be entirely surprising that, as a group, the returns from trading badly trail the overall market.

Related Reading:

Why do ETF Investors do worse than Index Mutual Fund Investors? is brought to you by Canadian Capitalist -- Helping you to invest & prosper.

CIBC Index Mutual Funds

Canadian Capitalist — Thu, 19 Feb 2009 16:35:59 +0000

At first glance, index mutual funds available from CIBC sport expenses that are a bit on the high side. Unlike TD e-Series funds, which charge MERs ranging from 0.31 to 0.48, CIBC’s index funds charge MERs that are about 1%. But as a reader pointed out the other day, CIBC offers a management fee distribution discount of 0.63% for investors who hold more than $150,000 in their index mutual funds. Investors with more than $500,000 in CIBC index funds can get a discount of 0.68%. According to CIBC the discount “is calculated and accrued daily and distributed to investors as a special distribution that is reinvested in additional units of the relevant Fund on a quarterly basis”.

Apart from the MER rebate, CIBC index funds are interesting because the line up includes funds, which track indices, that are not available through TD e-Series funds or Altamira Precision Series funds:

CIBC Canadian Short-Term Bond Fund (CIB489, MER 1.25%) tracks the DEX Short-Term Bond Index.
CIBC Canadian Bond Index Fund (CIB503, MER 1.0%) tracks the DEX Universe Bond Index.
CIBC Canadian Index Fund (CIB300, MER 1.0%) tracks the S&P/TSX Composite Index
CIBC US Broad Market Index Fund (CIB484, MER 1.0%) tracks the Dow Jones Wilshire 5000 index and provides a one-stop exposure to the entire US stock market.
CIBC International Index Fund (CIB510, MER 1.0%) tracks the MSCI EAFE Index, which provides exposure to Europe, Japan and Australia.
CIBC Emerging Markets Index Fund (CIB519, MER 1.2%) tracks the MSCI Emerging Markets Index.

Note that the MERs were obtained from the latest prospectus and do not include discounts that may be applicable. CIBC also has index funds tracking global bonds, the S&P 500, Europe, Japan, Asia-Pacific markets and a balanced index fund. CIBC’s index funds are also available through PC Financial, which offers a rebate of 10 basis points. A comparison of no-load, low-MER index mutual funds is available on Bylo’s website.

Though CIBC’s mutual funds are interesting, passive investors can do better elsewhere. Investors with smaller portfolios will find TD e-Series funds significantly cheaper and those with larger portfolios will find ETFs far cheaper even after accounting for trading commissions.

Related Reading:

CIBC Index Mutual Funds is brought to you by Canadian Capitalist -- Helping you to invest & prosper.

Yes, you can index using mutual funds

Canadian Capitalist — Mon, 11 Aug 2008 04:42:04 +0000

The weekend edition of the Globe and Mail carried a column by Noreen Rasbach, who is pondering a switch from mutual funds to ETFs, but is worried about the extra costs for small investors:

One of the downsides of ETFs is that they are bought and sold on exchanges, so you have to pay commissions, and it’s tough and expensive to do for people who set aside small amounts to invest each month.

While I am a huge fan of Exchange-Traded Funds (ETFs), it should be remembered that they are merely a tool to achieve an objective: to track broad stock market indexes at the lowest possible total cost. That objective can also be achieved by investing in index mutual funds. ETFs have lower MERs but investors pay a trading commission for each transaction. Index mutual funds, on the other hand, can be purchased in small amounts, typically without any fees but the MER is higher. A further advantage of mutual funds is that any distributions can be reinvested without any charge.

An investor just starting out can build a fairly diversified portfolio using just a few index mutual funds and can switch to an equivalent ETF after accumulating sufficient funds. One thumb rule that could be used to guide when to make the switch is to require the MER differential to pay for the trading commission within one year.

For instance, the TD e-Series Canadian Index Fund (TDB900) has a MER of 0.31% and the iShares CDN Composite Index Fund (XIC) has a MER of 0.25%. An investor paying $10 for each trade could make a switch after accumulating $16,700 in TDB900. Note that the switch can be made sooner if the MER differential is larger. The TD e-Series US Index Fund has a MER of 0.33% but the cheapest equivalent ETF costs just 0.09%, which would imply that the swap could be made with $4,200 (ignoring the cost of currency conversion).

Investors should also pay attention to the tax consequences of a swap: taxable accounts may take a capital gains hit when an index fund is sold to buy an ETF.

Related Reading:

Yes, you can index using mutual funds is brought to you by Canadian Capitalist -- Helping you to invest & prosper.

Indexing Canadian Equities through XIU / XIC

Canadian Capitalist — Mon, 07 Jul 2008 23:31:30 +0000

Canadian investors who want to passively track our equity markets through ETFs have two choices – the iShares CDN Large Cap 60 Index Fund (XIU) or the iShares CDN Capped Composite Index Fund (XIC). As the name suggests, the XIU tracks the performance of a capitalization-weighted index of 60 large, liquid stocks that trade on the TSX. The MER for the ETF at 0.17% is the lowest for a Canadian equity fund. The XIC tracks the performance of the broader TSX Composite index, which is composed of more than 250 stocks, and is slightly more expensive, charging a MER of 0.25%.

Either ETF would be a fine choice for the Canadian equity portion but, in my opinion, the XIC is a slightly better choice as it tracks a broader index and the weight of a single stock is capped at 10%. The XIC allows passive investors to avoid the “Nortel effect” or concentration in a single stock. Recall that in 2000, at its 52-week high, Nortel (TSX: NT) alone accounted for 34.2% of the TSE 300 Index. On the downside, the XIC is far less liquid and the bid-ask spread could be as much as 10 times larger when compared to XIU. However, this shouldn’t be a huge concern for long-term, buy-and-hold investors as the cost will be negligible when spread over the entire holding period of XIC, which could be decades.

XIC was introduced to track the capped version of the Large Cap 60 Index but in the fall of 2005, the mandate for the fund was changed to track the TSX Capped Composite Index. XIC is the appropriate benchmark for tracking the performance of active management, whether it is mutual funds or a portfolio of Canadian stocks.

Useful links
S&P/TSX 60 Factsheet from Standard & Poors.
S&P/TSX Capped Composite Index Factsheet from Standard & Poors.
Standard & Poors versus Active (SPIVA) reports.
Shakespeare’s Primer — Canadian Content chapter.

Note: Don’t forget to enter your name in the draw for one copy of The Intelligent Portfolio. Entries will be accepted until 8 P.M. EDT on Friday, July 11, 2008.

Related Reading:

Indexing Canadian Equities through XIU / XIC is brought to you by Canadian Capitalist -- Helping you to invest & prosper.

Flavours of an Index Fund

Canadian Capitalist — Tue, 29 Jan 2008 03:17:43 +0000

The following question is from Jamie:

My portfolio is quite similar to your Sleepy Mini Portfolio with a few variations in asset allocation. However, I’ve come across the currency neutral versions of the US and International funds. I’m not sure what the advantages and disadvantages of the three options ($CAD, $USD, Neutral) are and how to evaluate the three funds.

The TD e-Series of index mutual funds has three flavours of funds that track the S&P 500 – TD US Index (TDB902), TD US Index US$ (TDB952) and TD US Index Currency Neutral (TDB904) – and two funds that track the MSCI EAFE Index – TD International Index (TDB911) and TD International Index Currency Neutral (TDB905). TDB952 is different from other funds because it is denominated in US dollars (i.e. you buy using US funds and when you sell you receive US funds) and simply tracks the S&P 500.

TDB902 tracks the S&P 500 in Canadian dollar terms. In other words, the returns obtained from the fund will be the total return of the S&P 500 adjusted for the changes in the Canadian dollar vis-à-vis the US dollar during the same time period. TDB904 hedges the currency exposure for a small extra fee of 0.15% and is designed to provide the same total return as the S&P 500 in its local currency, in this case the US dollar.

For example, let’s say that the S&P 500 was at 1000 and the Canadian dollar at par when you purchased TDB902. One year later, the S&P 500 is at 1100 and the loonie fetches 90 cents US. Your return from the fund, ignoring dividends and assuming there is no tracking error, would be 22%: 10% from the increase in the value of the S&P 500 and 11% from the increase in the value of the greenback. If you had purchased TDB904 instead, you would have made 10% because the currency effect would be hedged away.

Similarly, TDB911 captures the return of the MSCI EAFE Index, which tracks markets in Europe, Japan and Australia, in Canadian dollars and TDB952 hedges the exposure of our dollar to a basket of currencies such as Euros, Pounds, the Yen and the Aussie Dollar.

The fund to use to capture the foreign currency exposure is a matter of personal preference. I personally prefer using unhedged positions because (a) It is cheaper (b) In the long run, currency effects will average out (c) The value of hedging is questionable when a basket of currencies are involved and (d) While currencies on their own have zero expected return over cash, adding them to a portfolio reduces volatility and offers diversification benefits. Admittedly, not hedging the foreign equity positions has not worked out very well in the past few years and you can justifiably hold the opposite view point.

Related Reading:

Flavours of an Index Fund is brought to you by Canadian Capitalist -- Helping you to invest & prosper.

ING Direct’s Low-Cost Mutual Funds

Canadian Capitalist — Wed, 16 Jan 2008 00:00:56 +0000

After innovating and leading in online high-interest savings accounts for years, ING Direct is introducing three low-cost, index-based, mutual funds under the “Streetwise” name. The Streetwise funds offer one-stop convenience for all-inclusive fees of 1% – no minimums, no sales loads and no administration fees. The Balanced Streetwise fund has a classic portfolio split – 40% in Canadian Bonds and the 60% in stocks, split equally between the S&P/TSX 60 index, S&P 500 and MSCI EAFE. ING also offers a slightly more aggressive version with 25% in bonds and 75% in stocks and an income version with a 70% allocation to bonds.

While the MER at 1% is a bit steep and you can construct the same portfolio with TD e-Series Mutual Index Funds for less than half the cost, ING’s mutual funds are even cheaper than TD Bank’s indexed portfolios. It is hard not to get excited when a major player is promising to bring low cost, passive investing for the smallest investor and I hope that costs will only go down from here.

Related Reading:

ING Direct’s Low-Cost Mutual Funds is brought to you by Canadian Capitalist -- Helping you to invest & prosper.