Couch Potato Basics, Part 3: Transparency

This post is the third in a five-part series outlining the primary benefits of the Couch Potato strategy.

Have you ever tried to learn exactly what stocks or bonds are held in a mutual fund? Don’t bother: it’s impossible.

Mutual funds are required to disclose their holdings only once each quarter, and by the time those reports are released the makeup will have already changed: the most you’ll learn is what the top holdings were weeks or months ago. That makes buying a mutual fund an act of faith as much as anything else.

ETFs, on the other hand, are refreshingly transparent. Their holdings are published every day on the fund company’s website. That makes comparing funds a breeze.

Say you’re trying to decide whether to buy the iShares Canadian Dividend Index Fund (XDV) or its competitor, the Claymore S&P/TSX Canadian Dividend ETF (CDZ). By visiting their websites and clicking the “Holdings” link, you’ll learn that XDV holds 30 stocks, while CDZ holds 56. You’ll know exactly what proportion each stocks represents in each fund. You can compare their weightings in the various sectors, and see their current yields. Try doing the same comparison between dividend mutual funds and see far you get.

Transparency is also crucial when you’re considering a bond ETF. Not only can you determine each and every holding—the iShares website lists all 297 bonds in its Canadian Bond Index Fund (XBB)—but you can also learn the fund’s current yield, average term to maturity, and duration (sensitivity to interest rates), information that is difficult or impossible to find for actively managed bond funds.

Some would argue that knowing exactly which securities a fund holds is information overkill. Shouldn’t you trust the manager’s expertise? Maybe. But chances are the manager is doing more than simply picking stocks and bonds. The prospectus of one Canadian equity fund I pulled at random reveals that it can also hold:

  • up to 30% of its assets in foreign property
  • other mutual funds
  • a significant portion of its assets in cash or short-term debt securities as a defensive measure
  • derivatives for hedging or non-hedging purposes

Of course, you’re unlikely to know which of these strategies the manger is employing at any given time.

One of the most basic truths of investment wisdom is, “Don’t buy what you don’t understand.” That would seem to apply to most actively managed mutual funds.

Part 1 : Low costs

Part 2: Pure asset allocation

Part 4: Flexibility

One Response to Couch Potato Basics, Part 3: Transparency

  1. mike macdonald January 23, 2010 at 5:42 pm #

    Transparency also includes fees…..again the MF folks hide fees and do not even tell you what GST you pay for fear you will then reverse calculate your real fees!

Leave a Reply