Archive | November, 2011

Can the Pros Time the Market?

I never meant to make you cry
And though I know I shouldn’t call
It just reminds us of the cost
Of everything we’ve lost
Bad timing, that’s all
Bad Timing, Blue Rodeo

One of the promises made by active managers is that they can move to cash before the markets tank and then get reinvested before they recover. When markets are as volatile as they have been in recent years, a manager with this skill would be something of a hero.

I recently looked at the record of actively managed mutual funds during bear markets for an article just published in Canadian MoneySaver. I found that there were indeed periods where managers were able to protect investors from losses. The problem was that defensive mangers were usually late to the recovery party. As a result, over an entire market cycle most investors are usually better off staying fully invested all the time.

Shortly after the article appeared, Dave Dennis of Newmarket, Ont., explained that he had done his own informal study on this subject a couple of years ago and generously agreed to share his findings.

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How to Pick Last Year’s Winners

For several years now, I’ve been encouraged that Canadians are coming around to the idea that trying to pick winning funds or this year’s hot asset class is a loser’s game. And then I read something like Gordon Pape’s recent Fund Library article, ETF Winners, and I realize we have a long way to go.

The article looks at the “outstanding performances” of three ETFs this year: the Claymore Gold Bullion (CGL), the Horizons COMEX Gold (HUG) and the iShares S&P/TSX Capped REIT (XRE). What makes these funds winners? They had the highest returns, of course.

For a distressingly large number of media commentators and investors, recent performance is still the only criterion that matters. “If you invested in gold and real estate this year, you were a winner. If you owned a globally diversified portfolio of stocks, you were a loser. Better luck next time.”

Let’s start by pointing out that the three ETFs Pape names are passively managed. So the fact that gold had another great year and real estate outperformed other sectors does not make these particular funds “outstanding” in any way.

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Why We Still Need Indexes

The BMO Canadian Dividend ETF (ZDV), launched last month, is unusual among dividend ETFs in that it does not track an index. Instead, it follows a “rules-based methodology” to screen stocks according to yield, dividend growth and payout ratio.

Last week, I asked whether ETFs really need an index in order to play a role in a passively managed, low-cost and low-turnover portfolio. Instead of tracking a traditional third-party index, can an ETF’s fund manager simply draw up its own set of quantitative rules and accomplish the same thing? If I had to make that argument in court, I’d build my case this way:

Many indexes are not transparent. Let’s all agree that transparency is paramount in a passively managed fund. But we should acknowledge that many well-known indexes are not particularly transparent.

Few people question whether funds tracking the S&P 500 or the Dow Jones Industrial Average are passive. And yet, although the major criteria are public knowledge, the companies in the S&P 500 are selected by a committee. The DJIA is even more of a black box—there’s nothing at all transparent about how this granddaddy of indexes is built.

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Do ETFs Need an Index?

Given the popularity of investing for yield these days, it’s not surprising that BMO’s most recent product launch included the brand new BMO Canadian Dividend ETF (ZDV). But this fund does have at least one surprising trait—one that suggests the direction the ETF industry may be heading. What makes ZDV different from its competitors at iShares and Claymore is that it does not track an index.

In a previous post, I discussed the future of ETFs with Oliver McMahon, iShares Canada’s director of product management. “A lot of the products you’re going to see in the future will not track an index,” he predicted. “The holdings are still going to be fully transparent, and they’re going to be passive investments: the portfolio manager is not trying to derive alpha. But rather than paying a provider to produce an index, the methodology may just be determined in-house.”

That seems to be the case with the new BMO dividend ETF. According to the prospectus, ZDV and three others launched at the same time “are not index mutual funds and are managed in the discretion of the Manager in accordance with their investment strategies and,

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ETF Risks in Perspective: Securities Lending

This is the final post in a series of three looking at the potential risks that ETFs may pose to the stability of financial markets. The previous two discussed synthetic and leveraged ETFs. Now we’ll take a look at the practice of securities lending.

Many active traders, including hedge funds and prop traders at investment banks, engage in short selling when the they believe a stock is about to fall in price. For example, if a company is trading at $20, a short seller might borrow shares and sell them on the open market for that price. If the stock falls to $18, the trader can then buy it at this lower price, return the shares to the lender, and pocket a profit of $2 per share (before costs).

Firms that borrow shares need to get them from somewhere, and the most common lenders are mutual funds, ETFs and pension funds, who use securities lending agents as intermediaries. When a fund lends shares to a short seller, it collects a fee for doing so.

The problem

The main concern about securities lending is common to all funds,

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Vanguard Drops the Gloves

It’s not easy to make a splash in the crowded ETF space these days. Many of the new products we’ve seen in the last year or so have been clones of existing ETFs or exotic specialty funds. Any Canadian investor who wants to build a diversified portfolio with ETFs has more than enough choice already.

That was the challenge for Vanguard Canada when they announced they’d by launching a family of ETFs this year. Given the company’s reputation for rock-bottom fees, there was a lot of speculation about whether they would try to compete on price. Even if none of their ETFs is radically different from their competition, they could grab some market share from their competitors by offering similar products with much lower fees.

Well, Vanguard has just released the costs of its new ETFs, which will start trading in the coming weeks. It looks like they’ve lived up to that promise:


Vanguard MSCI Canada

Vanguard MSCI U.S. Broad Market (CAD-hedged)

Vanguard MSCI EAFE (CAD-hedged)

Vanguard MSCI Emerging Markets

Vanguard Canadian Aggregate Bond

Vanguard Canadian Short-Term Bond


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Review: Millionaire Teacher

It’s hard not to respect Andrew Hallam. I first learned about him in the pages of MoneySense, where he described how his investment club (made up of fellow teachers) had beaten the S&P 500 year after year. Hallam eventually amassed a portfolio worth more than a million bucks on a decidedly modest salary.

But that’s not why I respect him. Most people in his shoes would have written a book with a title like, How to Get Stinking Rich Now! Secrets From a Stock-Picking Savant. Not Hallam. Instead, he set about encouraging people to live frugally, save money, and invest in index funds, often buying boxes of John Bogle’s books and handing them out to his colleagues.

Now he’s written his own book with a similar message. Millionaire Teacher presents Hallam’s nine rules of financial success. Rule 1 is the one most investment books ignore: your personal savings rate—not your investment choices—is the most important factor in determining your wealth. The road to riches, he explains, is usually mundane: live within your means, avoid the pitfalls of easy credit and overconsumption,

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