Archive | April, 2011

Tracking Errors on Bond and Commodity ETFs

The table below shows the tracking error of Canadian bond and commodity ETFs in 2010.

To make sure you understand these numbers in their proper context, see my earlier post on tracking errors for Canadian equity ETFs.

Fund
Index
Tracking

Broad bond market
Ticker
return
return
error

iShares DEX Universe Bond
XBB
6.4%
6.7%
-0.4%

TD Canadian Bond index – e-Series
TDB909
6.4%
6.7%
-0.3%

TD Canadian Bond index – I-Series
TDB966
6.0%
6.7%
-0.7%

BMO Aggregate Bond
ZAG
5.1%
5.4%
-0.2%

Claymore Advantaged Canadian Bond
CAB
5.2%
6.2%
-1.0%

iShares DEX Long Term Bond
XLB
12.1%
12.5%
-0.4%

iShares DEX Short Term Bond
XSB
3.2%
3.6%
-0.3%

Government bonds

iShares DEX All Government Bond
XGB
6.1%
6.5%
-0.5%

Claymore 1-5 Yr Laddered Gov’t Bond
CLF
3.3%
3.5%
-0.2%
(1)

BMO Short Provincial Bond
ZPS
3.5%
3.8%
-0.3%

BMO Short Federal Bond
ZFS
2.9%
3.2%
-0.3%

BMO Long Federal Bond
ZFL
5.7%
5.9%
-0.1%
(2)

BMO Emerging Markets Bond *
ZEF
8.5%
9.1%
-0.6%
(2)

Corporate bonds

iShares DEX All Corporate Bond
XCB
6.6%
7.3%
-0.8%

Claymore 1-5 Yr Laddered Corp Bond
CBO
3.8%
4.0%
-0.2%

BMO Short Corporate Bond
ZCS
3.9%
4.3%
-0.4%

BMO Mid Corporate Bond
ZCM
5.8%
6.1%
-0.3%
(2)

BMO Long Corporate Bond
ZLC
10.7%
11.5%
-0.8%
(2)

Real-return bonds

iShares DEX Real Return Bond
XRB
10.6%
11.1%
-0.5%

BMO Real Return Bond
ZRR
7.0%
7.2%
-0.2%
(2)

Commodities

Claymore Gold Bullion
CGL
26.6%
29.2%
-2.7%
(3)

Horizons BetaPro COMEX Gold
HUG
26.8%
28.6%
-1.8%

Horizons BetaPro COMEX Silver
HUZ
77.2%
81.6%
-4.4%
(4)

Horizons BetaPro NYMEX Crude Oil
HUC
4.8%
8.0%
-3.2%

Horizons BetaPro NYMEX Natural Gas
HUN
-37.6%
-36.3%
-1.3%

Claymore Natural Gas Commodity
GAS
-49.8%
-48.2%
-1.6%

Notes:

1.

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Tracking Errors on US and International ETFs

The table below shows the tracking error of U.S. and international equity ETFs in 2010.

To make sure you understand these numbers in their proper context, see yesterday’s post about tracking errors on Canadian equity ETFs.

Fund
Index
Tracking

US equity (hedged)
Ticker
return
return
error

iShares S&P 500
XSP
13.5%
13.5%
0.0%
(1)

TD US Index Currency Neutral – e
TDB904
12.6%
13.5%
-0.9%

RBC US Index Currency Neutral
RBF558
12.6%
15.1%
-2.5%

Altamira US Index Currency Neutral
NBC856
13.0%
15.1%
-2.1%

Claymore US Fundamental
CLU
16.7%
18.3%
-1.6%
(2)

BMO US Equity
ZUE
11.2%
11.8%
-0.7%

BMO Dow Jones Industrial Average
ZDJ
11.9%
12.8%
-0.9%

Horizons S&P 500 Index
HXS
6.7%
6.5%
0.2%
(3)

US equity (non-hedged)

Claymore US Fundamental
CLU.C
11.8%
14.1%
-2.3%

TD US Index – e
TDB902
8.4%
9.2%
-0.8%

RBC US Index
RBF557
8.0%
9.2%
-1.2%

Altamira US Index
NBC846
7.5%
8.3%
-0.7%

International equity (hedged)

iShares MSCI EAFE
XIN
4.6%
4.6%
0.0%
(4)

TD Int’l Index Currency Neutral – e
TDB905
4.0%
4.8%
-0.8%

RBC Int’l Index Currency Neutral
RBF559
3.3%
4.8%
-1.5%

BMO International Equity
ZDM
1.1%
5.7%
-4.6%
(5)

Claymore Japan Fundamental
CJP
-1.9%
0.4%
-2.3%
(6)

International equity (non-hedged)

Claymore International Fundamental
CIE
-0.2%
1.9%
-2.1%
(2)

TD International Index – e
TDB911
1.7%
2.1%
-0.4%

Altamira International Index
NBC839
0.9%
2.3%
-1.4%

Emerging markets equity

iShares MSCI Emerging Markets
XEM
10.0%
12.7%
-2.7%

BMO Emerging Markets Equity
ZEM
11.9%
15.3%
-3.4%
(5)

Claymore Broad Emerging Markets
CWO
16.2%
19.2%
-3.1%
(7)

Claymore BRIC
CBQ
8.8%
11.6%
-2.9%

Miscellaneous

Claymore Global Advantaged Dividend
CYH
11.1%
13.9%
-2.8%

Claymore Global Real Estate
CGR
13.1%
14.9%
-1.7%

iShares MSCI World
XWD
5.7%
5.9%
-0.2%

Notes:

1.

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Tracking Errors on Canadian ETFs

An index fund’s tracking error is the difference between the return of the fund and the return of its benchmark index. It’s an important measure of how well your index funds are performing, and it’s worth keeping an eye on. The table below shows the tracking error of Canadian equity ETFs and index funds in 2010.

As with many things in investing, raw numbers don’t tell the whole story. Here’s some guidance to help you understand the figures:

I’ve grouped the funds using some broad categories, but they don’t all track the same indexes, so it may be misleading to compare their absolute returns. The point here is to look at how well each fund tracked its own benchmark, not necessarily to compare funds that use different strategies within the same asset class.

When a fund has an unusually large tracking error, there may be a specific reason, such as change to the index during the year. If you’re alarmed by the performance of one of your ETFs or index funds, look in the Management Report of Fund Performance (available from the SEDAR website). You may find an explanation under the heading “Recent Developments.”

Funds report their returns in different ways.

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How to Track Down Tracking Error

How do you measure the performance of an index fund? That sounds like a simple question, but it’s one I think many investors still have trouble with. Otherwise I wouldn’t routinely get questions like, “How can you recommend US and international index funds when they have performed so poorly over the last 10 years?”

If you’re an index investor, your goal is to capture as much of the market’s return as possible. And since investing is never free, that means you’ll likely trail the market indexes by 20 to 60 basis points annually. That may sound like it’s setting the bar low, but the evidence is overwhelming that the majority of investors do much worse, whether they use actively managed mutual funds or pick individual securities.

None of the TD e-Series index funds, for example, has ever beaten the market. Yet they continue to outperform the vast majority of their peers: four of the six core funds in the e-Series family were first-quartile performers over the last 10 years, while the other two were in the second quartile.

So let’s return to the question of how you measure an index fund’s performance.

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How Did the Couch Potato Stack Up?

On Monday, I posted the 10-year performance record of the Global Couch Potato portfolio. From 2001 through 2010, if you invested in this extremely simple index portfolio using TD’s e-Series funds, and you rebalanced at the start of each year, you would have earned annualized returns between 3.19% and 4.03% — depending on whether you chose to hedge the currency risk in the US and international funds.

No one is jumping for joy over returns like that for a balanced portfolio of 40% bonds and 60% stocks. But as everyone knows, it was a dismal decade for the markets as whole. Here are the index returns for the 10 years ending in 2010, using the benchmarks tracked by the TD e-Series funds:

Canadian equities
S&P/TSX Composite
6.57%

US equities
S&P 500 ($Cdn)
-2.66%

S&P 500 ($US)
1.41%

International equities
MSCI EAFE ($Cdn)
-0.25%

MSCI EAFE (Local)
-2.18%

Canadian bonds
DEX Universe Bond
6.33%

The low-hanging fruit

To put the Global Couch Potato’s performance in context, let’s look at how the strategy held up against the alternatives. Maybe I’m setting the bar low here, but we’ll start by comparing it to the balanced mutual funds offered by the banks,

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The Couch Potato’s 10-Year Report Card

I’m regularly asked why I don’t provide performance data for my model portfolios. [Note: Long-term performance data are now available on the Model Portfolios page.] It’s a fair question, but unfortunately, compiling that information isn’t as straightforward as it sounds.

First, just one lonely ETF in my model portfolios has a 10-year track record: the iShares DEX Universe Bond Index Fund (XBB), and it had a completely different mandate when it was launched in November 2000. Many of the other ETFs were launched just five or six years ago, and a few are less than two years old. Short-term performance data is worthless for long-term investors.

Second, even if all the individual funds had a 10-year histories, computing returns for entire portfolios is more difficult —or at least more time-consuming — than many people realize. It means hunting down a lot of annual reports and entering the data into a spreadsheet that rebalances the portfolio every year. Even that would be fine for Canadian funds, but New York–listed ETFs report their returns in US dollars, so I would have to convert these into Canadian dollar terms — and for international funds,

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More New ETFs on the Horizon

The ETF market just keeps on growing. A couple of new products from Horizons focus on US-dollar investments, and while neither is a core holding for index investors, they may have some niche appeal.

The Horizons U.S. Dollar Currency ETF (DLR) is bought and sold on the TSX in Canadian dollars, and it gives investors exposure to fluctuations between the loonie and the greenback. Here’s how it works: if the two currencies are at par, the ETF will trade at an even $10 per share. If the US dollar falls to CAD $0.95, then the ETF’s price will be $9.50, and so on.

The fund charges a 0.45% management fee (the full MER will be higher), and trading commissions and bid-ask spreads will also add to the cost of DLR. But because the ETF is traded in Canadian dollars, there are no forex fees when you buy or sell it. As any Canadian knows, the currency exchange costs levied by banks and online brokerages are obscene — it’s not unusual to lose 1.5% or more when you buy, and the same amount again when you sell.

DLR’s holdings are all US cash equivalents,

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Living on the Hedge

Last week I discussed currency hedging as it applies to international equity ETFs. While iShares hedges currencies in its MSCI EAFE Index Fund (XIN), it does not do so with another of its popular international funds, the MSCI Emerging Markets Index Fund (XEM).

This fund holds stocks in more than 20 countries, and these are denominated in their native currencies: the Chinese renminbi, the Brazilian real, the Indian rupee, and so on. So Canadian investors will be exposed to currency risk with this ETF: if the loonie appreciates against any of these foreign currencies, the fund’s returns will be lower. If these foreign currencies strengthen, the returns of XEM will get a boost.

BMO’s entrant in this asset class, the BMO Emerging Markets Equity Index ETF (ZEM), also does not hedge currency and therefore has the same risk exposure. Not surprisingly, ZEM and XEM have performed almost identically.

However, the Claymore Broad Emerging Markets ETF (CWO) has blown away the iShares and BMO funds. Since November 2009, CWO has climbed more than 30%, compared with about 17% for ZEM and XEM.

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A Case Study in Currencies

In my last post, I explained that US-listed ETFs that hold overseas stocks do not expose Canadians to fluctuations in the US dollar. This is an important idea to understand if you’re comparing ETFs that hold international equities.

Vikash Jain, portfolio manager at the Toronto investment firm archerETF, was kind enough to dig into the data and provide a real-world example of this principle. In 2009 and 2010, the MSCI Brazil Index returned a total of 51% in its local currency, the Brazilian real (BRL). During that same two-year period, the following currency movements took place:

The BRL strengthened against the US dollar (USD) by 38%

The BRL strengthened against the Canadian dollar (CAD) by 14%

The CAD strengthened against the USD by 21%

Jain explained how all of this would have affected the returns of investors who held the iShares MSCI Brazil Index Fund (EWZ), which is traded in US dollars:

An American holding EWZ would have received the 51% index return, plus a big boost because the BRL shot up 38% against the greenback. In USD terms, he would have earned 109%.

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