Archive | June, 2012

An Overview of Commission-Free ETFs

Three discount brokerages in Canada now offer a menu of commission-free ETFs. Scotia iTrade pioneered this feature in Canada last September, then Qtrade Investor announced a similar offering about a month later, followed soon after by Virtual Brokers.

While index investors welcomed this development, the lineup of ETFs eligible for commission-free trades at all three brokerages is less than ideal. Narrowly focused funds dominate all three lists, which is fine if you want to invest in copper futures, Indian large caps, or the Australian dollar. But if you’re a long-term Couch Potato investor, you have to look a little harder for appropriate ETFs.

To help with that task, I’ve compiled a checklist of commission-free ETFs available from each of the brokerages, limiting the selection to broadly diversified funds that cover core asset classes. Funds that use currency hedging are marked with an asterisk (*).

Scotia
Qtrade
Virtual 

Fixed income

iTrade
Investor
Brokers

iShares 1-5 Year Laddered Gov’t Bond
CLF
x
x
x

iShares 1-5 Year Laddered Corp Bond
CBO
x
x
x

BMO Mid Federal Bond Index
ZFM

x

BMO Long Federal Bond
ZFL

x

BMO Long Corporate Bond
ZLC

x

iShares Advantaged Canadian Bond
CAB
x
x
x

iShares DEX Real Return Bond
XRB

x

BMO Real Return Bond
ZRR

x

iShares Advantaged High Yield Bond *
CHB
x
x
x

Canadian equity

Horizons S&P/TSX 60
HXT
x
x
x

iShares S&P/TSX Completion
XMD
x
x
x

iShares S&P/TSX SmallCap
XCS

x

iShares Dow Jones Canada Select Value
XCV

x

iShares Canadian Fundamental
CRQ
x

x

iShares S&P/TSX Cdn Dividend Aristocrats
CDZ
x

x

iShares S&P/TSX Cdn Preferred Share
CPD
x

x

US equity

Horizons S&P 500
HXS
x
x

BMO US Equity *
ZUE

x

iShares US Fundamental Index *
CLU
x

x

iShares US Fundamental Index
CLU.C
x

x

iShares S&P US Dividend Growers *
CUD
x

International and global equity

iShares International Fundamental
CIE
x
x
x

BMO International Equity *
ZDM

x

Vanguard MSCI EAFE *
VEF
x

iShares Global Monthly Adv Dividend
CYH
x

x

iShares Global Real Estate
CGR
x
x
x

Emerging markets equity

iShares MSCI Emerging Markets
XEM

x

iShares Broad Emerging Markets
CWO
x

x

BMO Emerging Markets Equity
ZEM

x

A breakdown of each asset class

Fixed income.

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What Are Normal Stock Market Returns?

How often in the last few years have investors said they’re staying out of the equity markets because of the volatility we’ve experienced recently? Many of them are waiting on the sidelines “until things are back to normal.”  That raises the question: what exactly is normal for equity returns?

Usually when people think of “normal” returns, they look at historical averages. According to the Credit Suisse Global Investment Yearbook, stock markets in the developed world delivered an annualized return of 8.5% over the last 112 years. Using that average as the midpoint in a range, it seems fair to say that “normal” historical stock returns are between 6% and 11%.

You might conclude, therefore, that it will be time to get back into equities once we’ve seen a couple of years with returns in this neighbourhood. That would be signal that things have “returned to normal,” right?

To test this idea, I looked at equity index returns for Canada, the US and international developed markets (in Canadian dollars) since 1970. Sure enough, during this 42-year period, annualized returns for all three asset class returns were within our expected range: 9.1%, 10.6%,

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Can You Have Too Much Diversification?

Is it possible for a portfolio to be too diversified? There are certainly a lot of articles making that claim. Investopedia even has one called The Dangers of Over-Diversifying Your Portfolio that concludes like this: “Diversification is like ice cream: it’s good, but only in reasonable quantities.”

Is the only free lunch in investing really just a fattening dessert? That depends on what type of investor you are.

Only active investors can overdiversify

The concept of overdiversification is only meaningful to investors bent on beating the market. If you’re a fund manager who is trying to outperform an index, it’s true that holding 100 stocks will make your job even harder than it already is. The more stocks you hold, the smaller the impact of your decisions, both good and bad. You might make a brilliant call on a company that doubles in value, but if that company makes up just 1% or 2% of your fund, the effect may be trivial.

An extremely overdiversified active fund manager is called a closet indexer: he or she holds a portfolio that closely resembles the benchmark, while charging fees that can be 20 times higher than an index fund.

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Vanguard Canada Gets a Six-Month Checkup

It’s now been a year since Vanguard set up shop in Canada, and just over six months since their ETFs began trading on the Toronto Stock Exchange. This week I had an opportunity to chat with Atul Tiwari, the affable managing director of Vanguard Investments Canada, about the company’s experience so far, and what we can expect in the future.

During their first six months, the Vanguard ETFs have gathered $230 million in assets under management. “I think we’re on track,” Tiwari said when I asked whether he’d expected that number to be higher. “We recognize there is a lot of competition in the market. Certainly mutual funds—although they are not growing to the same extent as ETFs—are still a formidable competitor that we’re up against.”

Vanguard is certainly competing in a difficult space. While it’s true that ETFs are attracting more and more dollars, much of that growth is driven by narrowly focused products. (The BMO Covered Call Canadian Banks ETF has attracted an astounding $758 million in its first 18 months.) But Vanguard has always stuck to broad-based, plain vanilla funds designed for long-term investors,

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A Homemade Principal-Protected Note

Given the widespread fear among investors today, it’s not surprising that financial institutions offer a staggering number of structured products that come with guarantees. Both market-linked GICs and principal-protected notes (PPNs) ensure you will not lose your initial investment, while also offering a chance to profit if the equity markets do well. Investors clearly find this promise appealing—with a lot of nudging from their advisors, no doubt.

Here’s an example. Say you have $50,000, and you’re jittery about the markets and discouraged by the low rates on savings accounts and regular GICs. Your advisor suggests a PPN like this one from Bank of Montreal, which guarantees your investment for six years and adds some possible upside based on the performance of the S&P/TSX 60 Index of large-cap Canadian stocks. No risk of loss and the potential to benefit from a stock market rally: what’s not to love?

A lot, actually. Read the fine print and you’ll learn that the product carries a 3% sales commission, which will cost you $1,500 right off the top, plus a deferred sales charge if you sell it within two years.

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Why Plans Should Come Before Products

When I wrote the MoneySense Guide to the Perfect Portfolio last year, I waited until Chapter 5 before I started discussing specific ETFs and index funds. That was a deliberate decision, because I feel strongly that we put far too much emphasis on investment products, and too little on the investing process.

Carl Richards agrees. As he explains in his book, The Behavior Gap, selecting investments should come at the end of the planning process, not the beginning: “You would never spend time researching and debating whether to travel by plane, train, or car until you figured out where you are going.”

During our recent interview, Carl elaborated on this idea. “The reason this is so important is that if we start with the product, we are inevitably going to be disappointed. And that leads to buying things high, and selling things low.” Instead, he says, start by giving your investing a context. “For instance, you may think education is really important for your kids and you want to save enough to send all of them to school. So how much will that cost?

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Carl Richards on Performance Chasing

A couple of posts ago, I asked why everyone isn’t beating the market when there are a dozen or more strategies that promise long-term outperformance. I argued that the problem wasn’t so much that the strategies themselves were flawed: the more important issue is that investors tend to quickly lose patience when their strategy isn’t working. What often happens is they move to another strategy that worked well recently, and soon they fall into a pattern of doing what Larry Swedroe calls “driving forward but looking in the rear-view mirror.”

I had an opportunity to sit down with Carl Richards, author of The Behavior Gap, when he was in Toronto for a presentation on May 22. Carl shared a couple of illuminating stories that make this point far more effectively than I did:

“I had been in the business maybe five years, working a brokerage that will remain unnamed but has a bull as its symbol. Part of what we did there was manager search and selection, and I remember this one occasion when we hired the Davis New York Venture Fund,

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