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.

This article has 16 comments

  1. I don’t know – I think the top 60 must have almost as much capitalization as the top 300 so I’m not sure the extra expense is worth it. I like that any one position is capped at 10% though.

    Both are pretty cheap really.

    Mike

  2. The only place where I am “indexing” is in my defined contribution pension plan at work, but the only index fund choice that I have is this segregated fund with TD Bank. From what I understand about segregated funds is that it’s actually an insurance product and it has absolutely nothing to do with the holdings in your portfolio. From what I understand, a seg fund is like a Las Vegas style betting pool where you are betting on a horse and at the end of the race the payout is based upon the purse and you didn’t own the horse through any part of the duration of the race. So, in investment terms, it’s like I’m betting on the index, but I don’t hold actual stock units inside that fund – it’s just a pool of money and the insurance company that is running that pool of money is like a “bookie”. When it’s time to cash out, then they only pay the difference between what you cash out at and what you bought in at… So, if you lose money, then the insurance company can just swipe all your money from your account. And if you gain money, then the insurance company only pays you the difference between what you are due and the cash in your account. The money that you physically put into the seg fund is ACTUALLY invested in T-bills or something like that…

    It’s a crazy business, this whole financial services industry. No wonder a lot of the “industry” people I’ve met through the years are major gambling addicts.

  3. Canadian Capitalist

    Mike: Actually, the XIU covers about 77% of the assets of XIC. I think of the relationship between XIU and XIC as the same between the S&P 500 and a total stock market index fund like the VTI. Holding the XIC automatically provides exposure to small caps weighted by their market capitalization.

  4. CC: Would two other choices for tracking Canadian stocks be the Claymore Canadian Fundamental (CRQ) and HBP 60 Bull Plus (HXU) ETFs?

  5. Canadian Capitalist

    Larry: I’m not sold on the advantages of fundamental indexes. Also, the key question is whether excess returns obtained in the past would persist in the future. There is plenty of evidence that markets have a habit of arbitraging away newly discovered strategies (one example is the disappearance of the small-cap effect in the years after its discovery).

    HBP 60 seems to be a trading vehicle, rather than a long-term buy-and-hold.

    Phil: Seg funds are not like betting on horses and my understanding is nothing close to what you describe. Seg funds are simply a special kind of mutual fund with three extra features thrown in (for a fee, of course): (1) A certain amount of creditor protection, as they are considered as insurance policies (2) Downside protection in the form of a promise to return 75% to 100% of capital in a certain number of years, usually ten and (3) a death benefit that allows the beneficiary to redeem the fund at the purchase price in the event of death within the 10 year period. In return for these extra features, you are charged a higher MER.

  6. Pingback: links for 2008-07-09 — midbach.com

  7. I think HXU can be a good trading vehicle if you can get the timing right. I have developed my own timer and applied to it to HXU. Similarly, I have a US timer that I apply to US market ETF’s (both single and double exposure). Unfortunately, HXU is so new that a long term backtest is not possible. The Proshare ETF’s for US markets have been around a little longer and therefore I can backtest my timer starting in August, 2006. The results so far are, in my opinion, quite favourable but the drawdowns on the double exposure ETF’s can be gut wrenching.

    Although I have developed my own timers, there are some simple rules out there for developing timers using the 20-day and 50-day moving averages that may work with HXU. It would be interesting to see if, over time, such simple timing when applied to double exposure ETF’s beats a buy-and-hold strategy.

  8. Pingback: Weekend Reading - July 11, 2008 | Million Dollar Journey

  9. Pingback: Weekly Dividend Investing Roundup - July 12, 2008 » The Dividend Guy Blog

  10. Pingback: squawkfox » Gardens and Gophers Oh My!

  11. Pingback: Why invest your own money?

  12. I’m not convinced about iShares Canadian index funds. You can get the TD Canadian Index e-Series fund for an MER of 0.31%. And you don’t have to spent time or money reinvesting your dividends.

  13. Canadian Capitalist

    Doug: It depends on the size of the Canadian equities portfolio. If I invest $7,200 in XIU, I can start saving on MER after the first year (assuming a $10 commission). For XIC, it is almost $17,000. Reinvesting isn’t usually a problem because synthetic DRIPs are available for many ETFs with discount brokers.

  14. Pingback: Recent URLs tagged Indexing - Urlrecorder

  15. Pingback: The Amateur Investor Manifesto, Part 3

  16. Pingback: Portfolio Size for Choosing ETFs over Index Funds — Canadian Capitalist