Even though I am in a wait-and-watch mode when it comes to the Horizon BetaPro S&P/TSX 60 ETF (HXT), I think HBP should be warmly applauded for introducing a new ETF is priced at about half that of its major competitors. For years, we’ve watched Vanguard competing with iShares on price and wondered when we’d see similar competition here. But, as Canadian Couch Potato pointed out, a lower cost alternative to the iShares S&P/TSX ETF (XIU) is likely not the first thing that many investors would wish for. So, what products or features would we like to see? Here is my wish list:

Cheap(er) REIT ETF

The iShares S&P/TSX Capped REIT Index (XRE) has a MER of 0.55% and has more than $1 billion in assets. And when BMO introduced a competing Equal Weight REITs ETF (ZRE), they also priced it at a MER of 0.55%. A new Canadian REIT ETF priced much cheaper than existing products, say in the 0.25% range will likely see lot of interest and enthusiasm from investors.

Currency-Unhedged EAFE ETF

Canadian investors have so much choice when it comes to ETF products that provide currency-hedged, broad-market exposure to developed international markets. However, investors prefering not to hedge their currency exposure have little choice but to access these markets through ETFs such as Vanguard Europe Pacific ETF (VEA) available in the U.S. However, by investing in the U.S., Canadian investors are exposed to U.S. Estate Taxes and currency conversion costs. A currency-unhedged EAFE ETF that holds international stocks directly would appeal to many investors.

Currency-Unhedged US Total Market ETF

It is hard to beat an ETF such as Vanguard Total Market ETF (VTI) on price. But, many wealthy Canadians wanting to avoid U.S. Estate Tax issues might be interested in a currency-unhedged, Canadian-listed U.S. Total Market ETF. Holding a Canadian-listed ETF that in turn invests in U.S. stocks will result in a withholding tax drag of 15 percent but this penalty may be acceptable to many Canadians.

World Ex-Canada Total Market ETF

Canadian investors wanting to diversify their portfolio globally invest in each of U.S., EAFE and Emerging Markets. There might be demand for an ETF product that combines the three different foreign market ETFs into one. The global markets will be weighted according to their share of the world market capitalization excluding Canada. The product will be modeled along the lines of the Vanguard FTSE All-World Ex-US ETF (VEU).

Pre-Authorized Cash Contribution and DRIP

One of the biggest knocks against ETFs is that it costs stock trading commissions to buy them. A small investor at a big bank brokerage is likely paying $30 for each trade and regular small investments in ETFs becomes prohibitively expensive. iShares, BMO and Horizons BetaPro can follow Claymore’s lead and establish a Pre-Authorized Cash Contributions (PACC) and Dividend Reinvestment Plan (DRIP). A PACC and DRIP will allow small investors to invest even small amounts of money at many discount brokers.

What new and unique ETF products and features would you like to see?

This article has 28 comments

  1. To me the 2 most glaring holes in the Canadian ETF market are cheap currency-unhedged EAFE and currency-unhedged US Total Market ETFs. An e-series mutual fund investor with a portfolio similar to your mini sleepy portfolio who, after accumulating over 25k(avoiding $100 RRSP annual fee), decides to move up to a TDW account has superior options in Canadian bonds(.30% XBB vs .48% TDB909) and Canadian equity(.25% XIC vs .31% TDB900) but has no better alternatives to her TDB902 and TDB911 mutual funds on the Canadian ETF market. Instead she must look to VTI and VEA south of the border.

  2. I think new entrants into the ETF and indexed mutual fund marketplace is the answer. Lets see vanguard come to Canada and launch some offerings and fidelity launch a series of index mutual funds. This is the key to new offerings.

    Most people in Canada don’t associate Fidelity with low cost funds but they have some excellent ultra low MER index funds in the US. Even if they doubled the MER for Canada they would still be competitive with ETFs in Canada. It would also be a great product for someone like me who buys on a monthly basis (dollar cost averages) and prefers full dividend reinvestment.

  3. Does your wish list include a sleepy/couch potato – one-size-fits-all thematic passive fund, which would allow investors to buy a single fund in their 20s and never buy anything else untill death? Or perhaps a momentum fund using a methodology similiar to that studied in the current issue of your parent magazine, MoneySense — (which outperformed couch-potato portfolios quite substantially).

  4. @GSP: I agree. Ideally the EAFE ETF will invest directly in overseas stocks (instead of simply holding a US ETF). That would allow us to avoid additional taxes in RRSP accounts.

    @Greg: We’ve seem rumours that Vanguard is planning to launch in Canada but we haven’t seen any official news yet.

    @Dale: A wrap fund is not on the top of my list because there is tremendous value in investing directly in component asset classes. It provides you two things: (1) You can adjust the asset allocation: for instance, dial back on risky assets as you age and (2) You can place your components in different locations based on tax considerations (bonds in RRSPs, for instance). And, no, a momentum fund isn’t in my list.

  5. Too bad a momentum fund isn’t on your list; according to MoneySense (and me) you would do better. But we have had that debate already.

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  7. I 2nd the request for a PACC at TDW.

  8. Nice post Ram!

    I’m with you on the PACC for ETFs; especially for iShares like XBB and XIU. That would be great. I think an online petition would help???

    Regarding the Canadian REIT ETF(s), I’d prefer to own two or three of the top Canadian REITs outright instead of owing the ETF. This way, I’ll never pay MERs at all.

    Cheers,
    Mark

  9. The only ETF that I have is in a category that wasn’t mentioned in your post. Commodities futures ETFs – they’re great for short term trades and speculation. I only own a natural gas one, but there are zillions (OK, maybe a couple dozen) of them out there for base metals, precious metals, agriculture, energy, etc.

  10. I think it’s worth noting that Claymore’s International Fundamental ETF (CIE) is unhedged. It doesn’t track the MSCI EAFE index, and it includes 5% Canadian holdings, but the other 95% gives unhedged exposure to the EAFE countries.

    I would like to see an ETF that offers global investment-grade bond exposure, hedged to Canadian dollars. There are several that hold high-yield bonds and emerging market debt, but I’m thinking of something more conservative, such as a fund that invests in the sovereign debt of developed countries.

    @Dale: Remember that the returns from the momentum strategy in the MoneySense piece are hypothetical. It’s not clear whether anyone actually achieved these returns, nor is it clear whether such a strategy could form the basis for a rules-based index. A momentum strategy would likely have to be actively managed.

  11. @Canadian Couch Potato… You mean “conservative” sovereign debt being the likes of Greece, Italy, Ireland, Spain, Portugal? I think the lowest of that bunch was at 500% of GDP in Italy, up to about 900% of GDP in Greece. Haha…

    The reason why I’m poking fun here is because I think the next major economic downturn will be due to the sovereign debt market. Not only the aforementioned European countries, but many Canadian provinces and US states will not be able to service their debt soon.

  12. @Phil S: I was thinking about the US, UK, Australia, Denmark, Switzerland, Sweden, Germany, Japan and other developed countries that have never defaulted on their sovereign debt.

    RE: “Many Canadian provinces and US states will not be able to service their debt soon.” That is an enormous speculation, and anyone who truly believes this should be hoarding tuna and bottled water not commodity ETFs.

  13. @Phil: I did some investigation of commodity ETFs this summer and I’m not convinced that long-term Canadian investors need them. Hence, it didn’t make my list. You can bet that some commodity ETFs are in the works by the major vendors.

    @Canadian Couch Potato: Personally, I want bonds to provide the safe haven in our portfolios. Hence, I prefer short-term bonds. Adding foreign bonds boosts the risk of the bond portion. Not that it’s a bad thing but I prefer to take my risks on the equity side.

    • @Canadian Couch Potato: I missed the “hedged to Canadian dollars” part of your comment. I think we can agree that unhedged foreign bonds adds risk to the bond portion due to currency fluctuations. That’s not desirable because the bond portion of one’s portfolio needs to provide safe haven in times of distress.

      But let’s say an investor hedges away the currency exposure. That reduces volatility but also results in foreign bond returns mimicking Canadian bonds (currency traders can chime in here because my understanding is that currency contracts take into account interest rate differentials, so hedging will eliminate the interest rate differential). But even for institutional investors, currency contracts have a cost. That means returns from currency hedged foreign bonds can be expected to be lower than Canadian bonds.

      If I understand correctly, DFA is making an argument that we can’t view portfolio components in isolation. It’s what happens when an asset class is added to a portfolio that matters. The imperfect correlations between hedged bonds of different countries could mean that diligent rebalancing could add to returns or reduce volatility. But I haven’t seen any convincing argument that foreign bonds are able to achieve that purpose once you account for the full costs of hedging (The DFA article mentions volatility and correlation but not returns net of hedging costs).

  14. @CC: Why does investing in investment-grade foreign bonds (with currency hedging) raise the risk of a portfolio?

    Dimensional Fund Advisors has been doing this for years, and they stick to short-term bonds only. According to DFA: “Introducing hedged foreign bonds into a domestic portfolio reduces the volatility of the portfolio. Portfolios of hedged global bonds take advantage of imperfect correlations among developed bond markets and enjoy the classic benefits of diversification. Further, given the global availability of highly rated debt issuers, this international diversification can be reached without sacrificing the credit standards maintained in domestic portfolios.”

    Here’s the link to their fund. Nothing like this exists in an ETF:
    http://www.dfaca.com/downloads/ca/pdf/fact_sheets/fixed_income/five_year_global_fund_f.pdf

  15. @Canadian Couch Potato. LOL@hoarding tuna & bottled water. Good one, but I think I would get sick of tuna after a while. Many US states are deep into deficit spending and are approaching the limit – Florida, California and Michigan are ones that have been in the news as being in deep doo-doo on a debt to tax revenue basis.

    Canadian provinces have quite a ways to go thanks to our “transfer payment” system, but when the traditional engine of our economy (Ontario) is a “have-not” province, one has to be concerned. For the provinces, I’m currently more concerned about some of our crown corporation debts as some of our power utilities, for example, are in sad financial shape.

    As for the ETFs of sovereign debt, you can’t really separate the risk in the Euro zone between the PIIGS and your Denmark & Germany. If the Euro sinks, they all sink. Even though the UK is not part of the monetary union, I suspect that they may be affected – guilty by association. Japan’s central bank has been intervening in currency markets creating some wacky rollercoaster rides.

  16. Is the US estate tax waived when you hold USD ETF’s in your RRSP?

    • @Jungle: I could be wrong on this but I don’t think it matters where US ETFs are located. All US assets are subject to US Estate Tax Liability calculations. With the circus surrounding US Estate Taxes happening in the US right now, a lot of Canadians might be caught in this net.

  17. Thanks CC.

  18. I wonder how far of a market hit you would take before you would sell…..even if Tax planning is a good thing.

  19. I wonder how far of a market hit you would take before you would sell…..even if Tax planning is a good thing. ,opps did something just go wrong

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  25. So we seem to have the unhedged Emerging Markets ETF and Real Estate ETF.

    What do you think the hold up is on EAFE International ETF Unhedged in CDN?

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