Archive | July, 2012

Comparing the Costs of Index Funds and ETFs

[Note: This post was updated in May 2014 when the ING Direct Streetwise Funds changed their name to the Tangerine Investment Funds.]

The growing popularity of index investing has a lot to do with the increasing number of ETFs available, and that’s largely a good thing. ETFs generally have lower management expense ratios (MERs) than index mutual funds in Canada, so they are usually the best choice for large portfolios, especially if you make infrequent lump-sum contributions.

But ETFs carry additional costs that are often ignored by beginning investors. Trading commissions are the most obvious: it typically costs $10 to buy or sell ETFs, while index mutual funds can be traded for free. (Some brokerages do offer a limited selection of commission-free ETFs, and a few independents offer trades for less than $10.)

Are index funds or ETFs right for you?

All of which is to say that as marvelous as ETFs are, they are often inferior to index mutual funds for investors with small accounts. My rough minimum for using ETFs is $50,000, but the actual cut-off varies a lot depending which specific ETFs or index funds you use,

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Are We In a Secular Bear Market?

If you’ve spent any time at a cottage this summer, away from the bright city lights, you’ve probably enjoyed some beautiful views of the Milky Way. Astronomers believe that our galaxy is a barred spiral, with several arms radiating from the center, but they don’t know its exact shape. The reason is simple: you can’t see a galaxy’s structure when you’re in the middle of it.

Before you think you’ve accidentally wandered onto an astronomy blog, there is an investing lesson in my celestial musings. Just like you can’t make out the shape of a galaxy unless you can view it from a distance, you can’t know whether you’re in a secular bear or bull market until after it’s over. That’s why it’s frustrating to keep reading that we’re in a secular bear market that began in 2000, most recently in the Financial Post this week. The fact is, we don’t know what kind of long-term market trend we’re in because, like an astronomer gazing out at the Milky Way, we’re looking at it from the inside.

What is a secular trend?

Let’s clarify some terminology before we go further.

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A New Book for Beginning Investors

Last fall, Glenn Cooke approached me with an idea. In addition to his work as an online life insurance broker, Glenn manages the FinanceAds.ca network that includes some of Canada’s most popular money bloggers. He wanted to bring together several of those bloggers to collaborate on a book, and I agreed to help out as editor.

After many months of work, I’m happy to announce that The Beginner’s Guide to Saving and Investing for Canadians is now available. The 100-page book is divided into five chapters, each written by a contributor with expertise in a specific area of personal finance. I’m sure you’ll recognize the names and the blogs:

Krystal Yee, a columnist at Moneyville and the blogger behind Give Me Back My Five Bucks, shows you how to create a budget. This may be the most important step in a financial plan, because investing won’t help you if you’re spending more than you earn.

Jim Yih of Retire Happy Blog explains where to save your money. He covers the basics of pension plans, RRSPs, Registered Education Savings Plans,

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Tim Pickering on Managed Futures, Part 2

Here’s part two of my interview with Tim Pickering, president of Auspice Capital Advisors, who manages both the Horizons Auspice Managed Futures Index ETF (HMF) and the iShares Broad Commodity Index Fund (CBR). You can read part one here.

Managed futures has traditionally been a hedge fund strategy, used mostly by institutions. Can it really be adapted for the retail ETF investor?

TP: All we’ve done at Auspice is said, this is what we do in our alpha program. It’s been around, it’s got a great history. So what are we are willing to make transparent by putting it in an index? How far are we willing to lift the kimono? Can we do that with an ETF-like price? We started talking about that years ago and people thought we were out of our minds. Nobody has done this before, and we are definitely getting a lot of eyebrow raising—that’s a polite way of putting it.

When it became known that we were publishing these broad commodities and managed futures indexes, I got a call from the CEO of a major company in Canada that has a managed futures program.

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Tim Pickering on Managed Futures, Part 1

On Monday I wrote about managed futures, a strategy that can add a layer of diversification to a traditional portfolio of stocks and bonds. Tim Pickering, president of Auspice Capital Advisors, manages both the Horizons Auspice Managed Futures Index ETF (HMF) and the iShares Broad Commodity Index Fund (CBR). I recently had a chance to interview Tim about these ETFs and the strategies they use. Here’s part one of our discussion. I’ll run part two on Friday.

I’ll start by asking you to simply explain what managed futures are.

TP: The general thesis of managed futures is trend following. We’re looking to capture trends by going long and short in the underlying futures. We are “direction agnostic,” which means it’s our job to capture the trend whether the market is going up or down. One of the most important points is that we are making these decisions based on quantitative measures, without regard for market fundamentals. That’s a key piece of the puzzle, because in order to be agnostic about the markets and to generate non-correlated returns, we need to be fundamentally non-biased.

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What Are Managed Futures?

One of the most difficult tasks in building a portfolio is finding asset classes that do not move in lockstep with stocks or bonds. Non-correlation—the tendency of an asset class to move independently of others—lowers a portfolios volatility, but it’s elusive.

Perhaps the most promising candidate is commodities: according to Larry Swedroe’s The Only Guide to Alternative Investments You’ll Ever Need, from 1973 through 2007 the S&P GCSI Commodities Index actually had negative correlation with US stocks, international stocks, and US Treasuries. That means they tended to zig when other asset classes zagged. Yet in 2008, commodities plunged along with all other risky assets.

However, a related asset class thrived during that crisis: managed futures. This term refers to strategies that trade commodity futures in an attempt to deliver positive returns in both up and down markets. (Many also include trading futures in currencies and interest rates.) Traditional commodity ETFs such as the iShares S&P GSCI Commodity-Indexed Trust (GSG) simply hold long positions in various crops, metals and energy products, and if commodity prices fall, so does the value of the fund.

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The Long and Short of Barbell Bond ETFs

Chalk up another one for ETF innovation in Canada. This week, First Asset launched three new bond ETFs that are the first of their kind in North America. And unlike some innovations in the ETF world, this one doesn’t involve any exotic, expensive and opaque derivatives. On the contrary, it uses a simple fixed-income strategy that’s been around for decades.

The new First Asset funds use what’s called a barbell strategy, which involves holding equal amounts of short-term and long-term bonds, with no allocation to intermediate maturities. According to the index methodology, the ETFs hold 50% of their assets in bonds with maturities between one and two years, and 50% in bonds that mature in 10 to 20 years. The short-term bucket includes both regular fixed-coupon bonds and floating-rate notes, which have coupons tied to prevailing rates. (The benefit of floating-rate notes is that they have extremely low interest rate risk: if rates rise, their prices remain more or less stable.)

Best of both worlds

So why would you use a barbell rather than simply holding a broad-based bond index fund?

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A New Service for Do-It-Yourself Investors

In the June issue of MoneySense, I wrote a feature that profiled three Canadian families who wanted to overhaul their investments and start fresh with low-cost ETF portfolios they could manage on their own. The idea for the story came about after Justin Bender and Shannon Dalziel of PWL Capital in Toronto approached me last December with an offer for charity: in exchange for a donation to the Centre for Addiction and Mental Health, they offered to help budding Couch Potatoes put together an investment plan and build ETF portfolios in a discount brokerage account.

The idea turned out to be hugely popular with readers—not only did Justin and Shannon get more inquires than they could handle in December, they received another wave of requests after my MoneySense article appeared. This isn’t too surprising, since very few fee-based investment advisors offer services for DIY investors. And while financial planners are happy to put do-it-yourselfers on the right track, many are not licensed to even recommend specific funds, let alone help you actually build your portfolio.

Now Justin and Shannon have decided to offer their DIY service to other index investors.

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How Will Rising Rates Affect Bonds?

Since the 2008–09 financial crisis caused bond yields to plunge to new lows, market forecasters have been predicting a rise in interest rates. And when bond investors think rates will increase, they tend to move to short-term bonds or cash. That has certainly been popular advice over the last three-and-a-half years.

As bond investors now know, the forecasters were spectacularly wrong about the direction of interest rates. Yields have fallen since the crisis, and as I wrote about in a recent feature for Canadian MoneySaver, anyone who moved to to short bonds or cash did far worse than investors who simply held the whole bond market. From 2009 through 2011, the iShares DEX Universe Bond (XBB) delivered an annualized return of 6.9%, compared with 4% for the iShares DEX Short Term Bond (XSB), and about 1.5% for cash.

The next three years

The fear of rising yields is even more palpable today, and the soothsayers may be proven right. But how badly would bond index funds suffer in a rising rate environment?

To get some insight, I ran some hypothetical scenarios to see how things might shake down if rates all along the yield curve climbed 100 basis points (1%) annually for the next three years.

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