Archive | 2011

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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ETF Risks in Perspective: Leveraged ETFs

This post is the second of three that will look at the potential risks that ETFs may pose to the stability of financial markets. Last week I discussed synthetic ETFs, which use derivatives called swaps to get exposure to their underlying indexes. Now we’ll examine leveraged ETFs.

Leveraged ETFs are designed to provide double or triple the daily return of their underlying index. The Horizons BetaPro S&P/TSX 60 Bull+ ETF (HXU), for example, promises twice the daily return of the popular large-cap Canadian equity index. If the index goes up 2% during the day, HBP will return 4%, and if the index loses 2%, the ETF’s return will be –4%. In the US, some providers even offer triple-leveraged ETFs, such as the Direxion Daily Large Cap Bull 3x Shares (BGU), which delivers three times the daily return of the Russell 1000 index.

A related family of products, called inverse ETFs, move in an opposite direction to the market. If Canadian large caps lose 2% in one day, the Horizons BetaPro S&P/TSX 60 Inverse ETF (HIX) will gain 2%, and vice versa.

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MoneySense Guide to the Perfect Portfolio

Canadian Couch Potato is pleased to announce the birth of The MoneySense Guide to the Perfect Portfolio. My new book has just hit the shelves across Canada: look for it on the magazine stand at Shoppers Drug Mart, Walmart, Chapters/Indigo and Loblaws stores, or buy it online. At just $9.95, it’s the same price as a single ETF trading commission.

The MoneySense Guide to the Perfect Portfolio is a roadmap for the do-it-yourself investor in Canada. It begins with my best attempt at laying out the case for passive investing: I explain the problems with mutual funds and active stock-picking strategies designed to beat the market, and I encourage investors to focus on the things they can control rather than basing their financial lives around the pursuit of an unlikely goal.

The next two chapters explain the importance of saving, setting targets and making a financial plan. This is an often neglected part of the investing process: it makes no sense to dwell on individual securities or funds unless you have some context for your investments. I look at the importance of gauging your risk profile and explain how you can build a portfolio that is suited to your goals.

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ETF Risks in Perspective: Synthetic ETFs

Not so long ago, ETFs were simple and transparent. But with the tremendous growth in the industry, ETFs have not only become more numerous, but also more complex and opaque. A number of influential bodies—including the International Monetary Fund, the Financial Stability Board, and the US Senate—have expressed concerns about how ETFs might damage the global financial markets. As a Canadian ETF investor, should you be worried about the funds in your portfolio?

In a series of three posts, I’ll take a look at the major concerns and try to give some perspective, with a specific focus on Canadian ETFs. Let’s kick off with a look at the new breed of “synthetic ETFs.”

The problem

Synthetic ETFs use a derivative called a total return swap to get exposure to the indexes they track. The ETF provider enters into a deal with a counterparty (usually a bank) who agrees to deliver the precise return of the index, minus a fee. While the swap structure has many potential benefits—including lower cost, smaller tracking error, and tax efficiency—it also introduces counterparty risk. If the bank fails to deliver the promised returns of the index,

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