Archive | September, 2012

5 ETFs That Should Be More Popular

In high school, the popular kids aren’t always the one’s with the best qualities. More often they’re the ones with the good looks, charm, and nice cars. Meanwhile, the kids with the brains and the bad haircuts—and the best long-term prospects—eat lunch alone.

The world of ETFs is often the same way. According to the Canadian ETF Association’s latest stats, the most popular funds include those tracking gold mining stocks, preferred shares, high-yield bonds and covered calls, each with assets between $800 million and $1.3 billion. There’s nothing necessarily wrong with any of these ETFs, but none would be near the top of my list of recommendations for the average investor. Meanwhile, there are many excellent funds that can’t find anyone to ask them to dance.

Here are five unjustly small Canadian ETFs that are worth a closer look: none has more than $70 million in assets, and several have much less.

1. Vanguard MSCI U.S. Broad Market (VUS)

Regular readers know I don’t like currency hedging because of its relentless drag on long-term returns, so it’s good to know that Vanguard Canada is planning a non-hedged S&P 500 ETF later this year.

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Foreign Withholding Tax: Which Fund Goes Where?

My previous post on foreign withholding taxes included a lot of information for investors to puzzle over. But unless you’re an accountant, you probably don’t care too deeply about the finer details. Most investors just want to answer a simple question: which fund should I put in which account?

Recall from the earlier post that there are five broad categories of funds you can use for US and international equities:

A. Canadian mutual fund or ETF that holds US or international stocks directly.
B. US-listed ETF that holds US stocks.
C. US-listed ETF that holds international stocks.
D. Canadian ETF that holds a US-listed ETF of US stocks.
E. Canadian ETF that holds a US-listed ETF of international stocks.

To help you make the most tax-efficient choice for each type of account, see the tables below. I’ve specified which of the above fund categories are the most tax-efficient, and which ones carry the largest withholding tax burden. Then I’ve included some comparisons of specific funds. In each case, the pairs track the same index and use the same currency hedging strategy. Once again, a big thanks to Justin Bender at PWL Capital for helping me sort through these details.

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Foreign Withholding Tax Explained

The Couch Potato strategy calls for a significant allocation to US and international stocks. When you live in a country with a small, poorly diversified stock market, global diversification is extremely important. But it does carry a price in the form of foreign withholding taxes.

Many countries levy a tax on dividends paid to foreign investors: the rate varies, but for US stocks it is 15%. (Foreign withholding taxes do not apply to capital gains.) With broad-based US index funds now yielding about 2%, the withholding tax amounts to an additional cost of 30 basis points. As you can see, the impact of withholding taxes can be far greater than that of management fees, which get a lot more attention.

To learn how much tax is withheld by your fund, click the “Distributions” tab on its web page and look under the heading “Foreign Tax Paid.” Here’s what the table looks like for the iShares S&P 500 (XSP). Notice the amount of tax paid for 2011 ($0.04388 per share) is approximately 15% of the foreign income received ($0.26866):

Investors and advisors are often unaware of how foreign withholding taxes affect returns,

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An ETF Pricing Puzzle

On Monday I looked at the relationship between an ETF’s daily trading volume and its liquidity. Unlike an individual stock, an infrequently traded ETF should not necessarily have a wide bid-ask spread. But low volume can cause some confusion for investors, and I’d like to share an example.

For a while now I’ve noticed that the Horizons S&P 500 (HXS) doesn’t always move in concert with its index. On Tuesday morning the S&P 500 was up about 0.5%, but my brokerage was showing HXS down about the same amount. Moreover, the quote said the last order was filled at $12.43, while the bid price was $12.46 and the ask was $12.48. That didn’t seem to make sense: the last price should be between the bid and ask, not several cents lower or higher.

I called Horizons to ask what was going on and got a helpful response from Jaime Purvis, Executive Vice-President, National Accounts. But first let’s review how ETFs are priced, and how this differs from mutual funds and individual stocks.

NAV versus market price

With a mutual fund,

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ETF Liquidity and Trading Volume

One of the most common misunderstandings about ETFs is that their daily trading volume has a large effect on their liquidity. Some investors avoid ETFs that don’t trade very often because they are concerned that making a purchase or sale will significantly affect the price: they worry, for example, that if they place a $10,000 buy order on a low-volume ETF, they will pay too much. Or conversely, if they place a $10,000 sell order, they will receive too little.

On the surface that’s a reasonable concern, because this is what happens with individual stocks. When a small investor buys or sells large-cap stocks, the market impact is zero. But if you place an order for a micro-cap company that is infrequently traded, your order may well move the price because of simple supply and demand. You can see this liquidity effect in the stock’s bid-ask spread: the difference between what you’d pay for Royal Bank and what you’d receive when you sell might be 0.05%. On a junior mining company it might be 2% to 4% or even more.

With ETFs, however, this isn’t the case. ETFs are open-end funds,

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Vanguard Announces Five New ETFs

When I spoke with Vanguard’s managing director Atul Tiwari back in June, he said the company would be announcing a new suite of ETFs in the coming months. That announcement arrived late yesterday afternoon: Vanguard will launch five new ETFs before the year is out.

Right now, all we know is the names of the funds and the indexes they track, but that’s enough to get a good idea of their strategies. Here’s my take on the new funds and where they fit in the Canadian ETF landscape:

Vanguard FTSE Canadian High Dividend Yield. No surprise here given the giddy popularity of dividends in recent years. Assuming this new ETF will use a strategy similar to that of the Vanguard High Dividend Yield (VYM), which also tracks a FTSE index, it will focus on stocks with above-average current yields rather than dividend growth. With that in mind, I’d guess it’s likely to be closer to the iShares S&P/TSX Equity Income (XEI) than to any other competitor. The management fee is 0.30%.

Vanguard FTSE Canadian Capped REIT. This real estate fund will go head-to-head with the iShares S&P/TSX Capped REIT (XRE),

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