Archive | 2010

Bonds, GICs and the Yield Illusion

If you like to keep the fixed-income side of your portfolio as safe as possible, there’s lots to like about the Claymore 1-5 Year Laddered Government Bond ETF (CLF). It carries one of the lowest management fees of any ETF in Canada at a paltry 0.15%. Its default risk is essentially zero, and its short duration means it’s not too vulnerable to rising interest rates. Finally, the ETF uses a laddered structure to spread out interest-rate risk.

However, for many income-hungry investors, the most attractive thing about CLF these days is its 4.5% yield. Indeed, Gordon Pape recommended CLF last month in a Moneyville article, arguing that it was far superior to the “negligible” returns from GICs. Unfortunately, this a classic example of how investors — and commentators who should know better — too often focus on yield while ignoring total return. In fact, CLF is not likely to outperform a comparable ladder of GICs in the foreseeable future. It may well do worse.

Here’s why yield can be an illusion. The bonds held by CLF all have fairly high coupons (ranging from 4.25% to 6.10%),

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Making a Visit to Moneyville

Canada’s largest newspaper, The Toronto Star, joined the universe of personal finance websites in September with the launch of Moneyville. The huge site contains a mix of news and features as well as regular blogs from writers such as the Star’s inimitable consumer advocate, Ellen Roseman.

This week Moneyville is running a three-part series of articles by yours truly:

In the first piece, I pick apart a common criticism of index-based ETFs: that they’re “just average” because they’ll never beat the market. This is an argument that advisors love to make, implying that they can help their clients do better. As I explain in the article, if you simply earn “average” returns — those delivered by the market indexes — you’ll trounce the majority of active mangers over every long period. (Coincidentally, The Oblivious Investor ran a blog post on just this topic yesterday.)

The second article looks at five reasons why ETFs are superior to mutual funds. While experienced index investors won’t learn anything new here, mutual fund refugees will find it a useful primer.

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Under the Hood: Claymore Global Monthly Advantaged Dividend ETF

This post is part of a series called Under the Hood, where l take a detailed look at specific Canadian ETFs or index funds.

The fund: Claymore Global Monthly Advantaged Dividend ETF (CYH)

The index: Zacks Global Multi-Asset Income Index, which was created specifically for Claymore. It combines the Zacks Multi-Asset Income Index (made up of U.S. securities) and the Zacks International Multi-Asset Income Index, which includes developed and emerging countries outside the U.S.

This is a “strategy index,” which means it is not designed to passively track the whole universe of dividend-paying stocks. Rather, the securities are hand-picked “using a proprietary model based on dividend growth, the capacity to increase the current dividend, liquidity, and dividend yield.” The methodology is not made public.

The most important thing to understand about the Zacks index is that it is not limited to common shares of dividend-paying companies. Almost half the index is made up of preferred stocks, American depositary receipts (ADRs), real estate investment trusts (REITs), master limited partnerships, and closed-end funds.

The cost: The fund’s MER is 0.67%,

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Lowering Your Currency Exchange Fees

With the Canadian dollar again hovering around parity, it seems like a good time to consider ETFs denominated in US dollars. But the problem of high currency exchange fees remains a problem for DIY investors, as I wrote about last month. This topic has generated a lot of discussion recently, and a number of useful resources have appeared to help investors make informed decisions about currency exchange costs.

First, The Globe and Mail just released its 12th annual review of online brokerages. This comprehensive survey ranks the major Canadian discount brokerages according to many categories, including costs, and features a table showing the cost to buy 100 shares of a stock trading at US$25. (The table is much more useful if you click the column heading “Total Transaction Cost” to sort it.)

According to the Globe’s numbers, TD Waterhouse has the lowest foreign exchange fees, well ahead of CIBC Investor’s Edge and Questrade. That was a surprise, to say the least. Even Canadian Capitalist, a satisfied TD Waterhouse client wrote, “I wouldn’t have expected TDW to end up at the top of the list.” Indeed,

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Ready, Willing and Able to Take Risk

Asset allocation is more art than science. There are no immutable laws to tell you what proportion of stocks and bonds should be in your portfolio. The best you can do is adopt rules of thumb. “Make your bond allocation equal to your age” is a popular one, as is “Don’t invest in equities if you will need the money within five years.” In the end, it comes down to a trade-off between risk and expected returns.

I found a lot of useful insights on asset allocation in Larry Swedroe’s newest book, The Only Guide You’ll Ever Need for the Right Financial Plan (Bloomberg/Wiley, 2010). Swedroe, who writes the Wise Investing blog at CBS MoneyWatch, is one of my favourite financial authors because he always backs up his arguments with hard data and practical advice.

His new book is written for an American audience and most of the financial planning advice isn’t useful for Canadians. However, a large part of the book is devoted to asset allocation decisions, which should be based on “the ability, willingness and need to take risk.” Let’s break down these three factors.

The ability to take risk

Swedroe says your ability to take risk depends on your investment horizon and the stability of your income (or human capital).

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Taking Risk in an RESP

My recent column in MoneySense offers suggestions for parents who want to use the Couch Potato strategy in a Registered Education Savings Plan (RESP).

Investing in an RESP presents some added challenges compared with a retirement account. First, the time horizon is usually shorter: even if you start contributing to an RESP when your child is born (and most parents don’t), you’ll start tapping the funds in no more than 18 years.

The account size is also much smaller. You’re not allowed to contribute more than $50,000 to an RESP, and most parents won’t ever hit that maximum. If your RRSP account isn’t that large now, we’re hoping it will be before you’re ready to retire.

For these reasons, I suggest that RESP investors use index funds rather than ETFs: something simple like the Global Couch Potato (assembled with TD e-Series funds) is all the diversification you need. That advice is echoed by Mike Holman, Money Smarts blogger and author of The RESP Book, whom I interviewed for the column.

There is one other idea in the article that I’d like to expand on.

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Rick Ferri’s Take on Gold

I recently had the privilege of interviewing Rick Ferri, founder of Portfolio Solutions, an investment management firm in Troy, Michigan. Rick is the author of several excellent books on ETFs, index funds and passive investing, including one of my favourites, All About Asset Allocation (McGraw Hill, 2010), which has just been released in a second edition.

One of the issues Ferri and I discussed was the outrageous popularity of investing in gold. SPDR Gold Shares (GLD) is now the second-largest largest ETF in the world, with more than $56 billion (US) in assets, something that would have been inconceivable five years ago. One of the most common reasons people give for buying gold is that it offers security in the event of financial or economic catastrophe. Here’s Ferri’s take on that logic:

“Everybody is putting their money into GLD. But it’s a piece of paper: they are not going to issue you gold bars. If the banking industry collapses, how are you going to get your gold? If Armageddon comes along you might say, ‘That’s OK, because I own gold.’ But you don’t own gold,

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The 50-Percent Solution

Investing can seem so complicated. Building a portfolio can involve dozens of decisions, each of which seems terribly important. Here are a few that readers have mulled over recently, according to emails I’ve received:

Should I use fundamentally weighted or traditional cap-weighted ETFs?
Should I hedge the currency in my US holdings?
Will dividend-focused equities outperform a broad-market ETF?
Short-term bonds or a broad-market bond fund?

All of these are thoughtful questions, but each involves a choice between two good alternatives: one is likely to turn out better over the long run, but there’s no way of knowing which one. And yet I regularly hear from readers who are sitting in cash—or worse, sitting in overpriced mutual funds—because they can’t decide which alternative to take.

There are lot of big questions in investing. Whether you use a stock-picking strategy or a passive Couch Potato portfolio matters a lot. Hiring an advisor or investing on your own will also make a dramatic difference. Dumping your GICs for high-yield bonds without understanding the risk? Definitely huge. Decisions like those above—where both alternatives are reasonable, and the superiority of one cannot be predicted—are much smaller.

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To Hedge or Not to Hedge

Last week I wrote about whether US-listed ETFs are really cheaper once you account for currency exchange fees, and then I looked at ways to reduce forex fees. The spreadsheet I created to compare US and Canadian ETFs allows investors to compare the costs using several assumptions.

One of those assumptions was to ignore currency hedging. Unfortunately, the reality is that the decision about whether or not to use hedging is likely to be the single most important factor affecting the return of your foreign investments. If the Canadian dollar moves up or down 15% over the period you’re invested, that will clearly have far more impact than a lower MER or a currency exchange fee. Too bad all we can do when it comes to currency fluctuations is guess.

Most Canadian ETFs with foreign holdings — notably XSP, XIN, CLU and CWO — use currency hedging. Not all of them do, however: unhedged international ETFs include the Claymore International Fundamental (CIE) and the iShares MSCI Emerging Markets Index Fund (XEM). Claymore also has an unhedged version of its US Fundamental Index ETF (CLU.C), though the trading volume is very low,

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