Another 5 Underrated Index Funds

Last week I presented a list of five Canadian ETFs I feel are underused compared with their billion-dollar competitors. Here’s are three more ETFs and a couple of index mutual funds I’d put in the same category.

1. PowerShares FTSE RAFI Canadian Fundamental (PXC)

The iShares Canadian Fundamental (CRQ) has been a high-profile ETF since it was launched in 2006, and it has outperformed the S&P/TSX Composite Index by more than 1% a year for the last five, despite a relatively high fee of 0.72%. This new PowerShares ETF, launched with little fanfare in January 2012, is tied to the exact same index as CRQ, but with a significantly lower management fee (0.51% including HST). Assuming it will track the index well and overcome the problems associated with low trading volume—and it’s too early to tell—it may be a compelling alternative for investors interested in fundamental indexing.

2. BMO Low Volatility Canadian Equity (ZLB)

I’ll start by saying I’m agnostic about low-volatility ETFs, as I’m still looking deeper into the research. But there is some evidence suggesting stocks with low beta—that is, low volatility relative to the broad market—have actually outperformed over long periods. What’s more interesting about ZLB is it avoids the overconcentration in banks, energy and materials that plagues most broad Canadian equity funds. Its 40 holdings include a much greater share of consumer retailers, telecoms and utilities, offering not only lower volatility but better diversification, too. (Interestingly, the sector breakdown of the newer iShares MSCI Canada Minimum Volatility is very different from ZLB’s.)

3. iShares Gold Trust (IGT)

Now this is a stealth ETF if there ever was one: it doesn’t even have a web page I can link to. That’s because IGT is a cross-listing of the iShares Gold Trust (IAU), a US product. Most investors looking for a TSX-listed gold ETF will gravitate to the iShares Gold Bullion Fund (CGL), which has grown to over $600 million in assets. The problem with CGL, however, is not only its relatively high fee (0.55%), but its bizarre use of currency hedging pegged to the US dollar. A non-hedged version (CGL.C) was launched in 2011, but IGT offers the same exposure to gold for less than half the fee (0.25%) and still allows you to trade in Canadian dollars.

4. ING Direct Streetwise Equity Growth Fund (INI240)

With an MER of 1.07%, the Streetwise Funds are expensive by index fund standards, especially if you choose a version that holds a lot of low-yield bonds. But this newest flavour, launched late last year, is an all-stock fund that may appeal to budding Couch Potatoes who aren’t ready for ETFs and aren’t willing to jump through flaming hoops to get the TD e-Series funds. It’s half Canadian, 25% US, and 25% international, rebalanced every quarter—and there’s no currency hedging on the foreign stocks. Investors can combine the fund with a GIC ladder from ING Direct to build a globally diversified balanced portfolio with no minimums, no account fees, and no need to open a brokerage account. Of course, that’s assuming ING’s new owner Scotiabank doesn’t change the rules.

5. TD Balanced Index Fund (TDB965)

Another one-stop solution, the TD Balanced Index Fund has a fee of 0.89%, a 14-year track record, and has outperformed its peer average for a decade, earning four stars from Morningstar. Yet along the way it has gathered a mere $68 million in assets. The TD Balanced Index is really only appropriate for conservative investors, since it holds 50% in bonds and cash: the rest is Canadian (about 32%), US (9%) and international (9%) stocks. Because it’s not part of TD’s e-Series, it’s available through any discount brokerage.

33 Responses to Another 5 Underrated Index Funds

  1. Jas October 1, 2012 at 1:17 pm #

    Thanks for another great post.

    Combining Streetwise 100% equities fund (INI240) with a low cost bond fund or bond ETF would make a very simple couch potato portfolio where one could adjust the proportion of bonds in the portfolio over the years (ie bonds % = your age). This is the kind of portfolio I could see my girlfriend or my mom&dad using…

  2. Jas October 1, 2012 at 1:27 pm #

    @CCP: About the GIC ladder with ING, how does it compare with a bond index fund with variable duration bonds?

  3. Canadian Couch Potato October 1, 2012 at 1:48 pm #

    @Jas: A five-year GIC ladder would have a shorter duration than a broad-based bond fund like XBB. It would be very close to CLF, but would actually pay a higher yield because there are no management fees and you get a small “liquidity premium” with GICs versus government bonds. GICs would also be more tax-efficient that CLF if you were holding them in a non-registered account.

  4. Joe K October 1, 2012 at 2:35 pm #

    @CCP
    “GICs would also be more tax-efficient that CLF if you were holding them in a non-registered account.”

    Can you explain why?

  5. Jas October 1, 2012 at 3:14 pm #

    @Joe K :
    I also wonder how a ladder of GICs can be more tax efficient than a bond fund/ETF.
    From what I understand, the interest earned each year on a non-registered GIC ladder (compound-interest) must be reported as income on your tax return, for the year earned, even though you will not actually receive the money until the GIC matures.

  6. Canadian Couch Potato October 1, 2012 at 3:20 pm #

    @Joe K and Jas: The reason is that the bond coupons on CLF are quite high (about 4.3%) and this is fully taxable. Because all of the bonds in CLF were bought at a premium, they will suffer small capital losses that will bring the yield to maturity down to about 1.5%.

    A GIC ladder would achieve approximately the same total return (i.e. 1.5%). But the GICs would have smaller interest payments, which means you lose less to tax.

    Here’s a full explanation: http://bit.ly/W9jeQL

  7. Nathan October 1, 2012 at 5:21 pm #

    Also a note that #1 would only be superior in an RRSP. In a TFSA the lost withholding taxes would make up the difference in MERs, and in a taxable account the taxation of dividends as foreign income would overwhelm it. That said, for RRSPs, it’s indeed a better deal!

    As far as #2, I’ve read a bit about this low beta anomaly, but I haven’t studied in any detail. Do you know whether these studies all just compare to the CAPM model, or if it has been shown that low-beta portfolios outperformed expectations even from a 3-factor perspective?

  8. gsp October 1, 2012 at 7:40 pm #

    @Nathan: #1 is a Canadian fund 100% invested in Canada, why would there be any tax witholding?

  9. Nathan October 1, 2012 at 7:49 pm #

    Gah, sorry, my mistake. Thought it was US Powershares for some reason. Thanks!

  10. Canadian Couch Potato October 1, 2012 at 8:33 pm #

    @Nathan: RE: the low volatility stuff, I’m still looking into it now, so I’m not sure of the details. Check out the work of Eric Falkenstein if you’re interested.

  11. Canadian October 1, 2012 at 11:00 pm #

    Left this comment over at your MoneySense blog, thought I was over here.
    Anyway, I have a reasonably small position in gold in my TFSA Scotia iTrade account in both CGL (25%) and CGL.C (75%). My CGL is up 10.2% and CGL.C is up 5.4%. I assume this would be approximately reversed if the CDN$ was not above the US$. Do you think this is a prudent way to hold my gold ETF’s. They are both commission free on iTrade.
    Thanks for your blog, I refer to it often.

  12. Nathan October 1, 2012 at 11:20 pm #

    Huh, was just looking at an old FF paper for a different reason and answered my own question. Check out section IV: http://papers.ssrn.com/sol3/papers.cfm?abstract_id=98678

    Basically, Fama and French themselves noted that their model does not do well with market betas different from 1, overestimating the effect of beta on returns. So even in a 3F world, low-beta portfolios have outperformed expectations. (The difference is, most of the variation we see in CAPM betas is due to the size and value factors, so 3F betas generally tend to be much closer to 1.)

  13. Canadian October 1, 2012 at 11:22 pm #

    Actually I see that my CBD Coreportfolio has equal amounts of both CGL and CGL.C

  14. Nathan October 2, 2012 at 1:24 am #

    This is interesting re: low volatility too: http://www.cbsnews.com/8301-505123_162-57480957/a-way-to-get-stock-like-returns-with-less-risk/

    It’s a blog post by Larry Swedroe from earlier this year, referencing a research paper from DFA. Basically it suggests that first, as expected, the out-performance of low beta portfolios is largely due to high value exposure. However, he also points out that these portfolios tend to have higher dividends as well, which makes them sensitive to the term risk factor. (IE: to some extent, they move with long-term bonds.) Putting the two together, along with some lucky sector concentrations along the way, explains the historical risk-adjusted out-performance of low-volatility. (Meaning that one could achieve the same thing using value funds combined with bonds.)

    Of course, that doesn’t mean low-volatility funds are bad. Conceivably they could be the most efficient way to access the value premium in some cases. There’s not enough history on any of the low-volatility ETFs to know for sure as yet, but once there is, 5-factor regressions (including the term and default factors) should be the way to find out.

  15. Canadian Couch Potato October 2, 2012 at 8:37 am #

    @Canadian: Holding CGL is essentially going long gold and short the US dollar. Personally, I think those are two different decisions and it doesn’t make much sense to combine them. In my opinion, if you want to add gold to a portfolio, it makes more sense to simply get gold exposure only through CGL.C (if you can trade it commission-free) or IGT.
    http://canadiancouchpotato.com/2011/07/28/claymores-cgl-when-buying-gold-isnt-enough/

  16. Que October 3, 2012 at 2:02 pm #

    Dan,

    Once PXC improves the tracking error, will you replace CRQ with PXC in your Über–Tuber portfolio, or are there other considerations?

    Another option for gold, is at Questrade you can invest directly in gold, and avoid the management fees, but pay 19.96/trade instead, may save you a lot of gold coin ;-)
    http://questrade.com/trading/gold.aspx

    Thanks for the ING option idea, I think its great for newbies, I will definitely recommend it to a couple of friends.

    Thanks,
    Que

  17. Andrew F October 3, 2012 at 4:10 pm #

    Que, you still need to pay $0.10/ounce/month for storage. That work out to $1.20/ounce/year, which at $1778/ounce works out to a cost of 6.8 basis points. Lower than the MER of all the gold ETFs out there, but not zero.

  18. Que October 3, 2012 at 4:48 pm #

    Thanks for pointing that out Andrew F. A nice reminder to read all the details and fine print.

    “All gold products available for purchase are stored at the Royal Canadian Mint. Gold purchased in margin accounts can be stored at the Mint or the physical gold can be shipped.”

    How awesome would it be to receive some “four nines fine” gold bars on your door step, reminds me of The Italian Job.

  19. J from Ottawa October 3, 2012 at 9:14 pm #

    I have been using TDB965 for monthly automatic contributions in a Qtrade account. Then at year end I sell it and rebalance the account, you can sell after 90 days with no penalty. Works well so far.

  20. Canadian Couch Potato October 3, 2012 at 11:25 pm #

    @Que: Once I am confident that PXC will be able to keep its tracking error low, sure, I would consider swapping it in the Uber-Tuber.

  21. Dale October 4, 2012 at 6:35 am #

    Sad to see ING D go. I worked on the advertising creative for ING Direct Canada and the US for a few years. Great people. Great mission.

    But, customers may be able to buy ETFs commission free at Scotia, once they combine some offerings. I will stick around for that.

  22. Oldie December 5, 2012 at 1:15 am #

    @CCP: The fact that PXC was worthy of serious attention, and that you were merely waiting for the tracking error to prove itself by staying low caught my eye; the full name FTSE RAFI® Developed ex U.S. 1000 Index initially puzzled me, as I was aware that FTSE 100 was a frequently quoted index of the London Stock exchange. On visiting the PXC website, it transpires that the FTSE group also calculates other indices, and the PXC tracks the “FTSE RAFI® Canada Index.” This ETF apparently gives investors exposure to “all Canadian equities in the FTSE RAFI® Developed ex U.S. 1000 Index” which suggested that the Canadian selections are a subset of a larger index including the Developed World excluding the US. A little further digging unearthed the fact that PowerShares also markets a product, PXS, that tracks this same larger index, the FTSE RAFI Developed Markets ex-U.S. Index.

    I was wondering, if PXC was worthy of serious consideration, whether the ETF tracking the “mother index” from which the FTSE RAFI® Canada Index was culled from, i.e. PXS, would also be worthy of considering for inclusion as the international component of the UberTuber portfolio.

  23. Canadian Couch Potato December 5, 2012 at 8:58 am #

    @Oldie: Yes, FTSE is simply the name of an index provider, just like S&P and MSCI, but when many people hear the “the FTSE” they think of the UK index, just like “the S&P” implies the S&P 500 in the States. FTSE has licensed the fundamental indexes created by Research Affiliates (RAFI) and applied them to equity and fixed income markets all over the world.

    We looked at PXS for the Uber-Tuber but concluded that using lower-cost iShares ETFs got a similar exposure to value and small stocks with considerably lower cost. PXS charges 0.75%, which is a bit too steep as far as I’m concerned.

  24. bettrave January 8, 2013 at 2:04 pm #

    Hi,
    What would probably give the best result with the probability of the rising interest rates:
    1- ING streetwise equity growth + either GIC or just a sving account (all ING)
    or
    2- ING index funds containing bonds (either the balance or balance growth portfolio)

    Thanks.

  25. Canadian Couch Potato January 8, 2013 at 2:15 pm #

    @Bettrave: Rising rates will harm long-term bonds more than GICs, and savings accounts will obviously benefit. But remember that trying to predict the direction of interest rates is just guessing. A more important consideration here is cost. Today a bond portfolio yields barely 2% and the Streetwise Portfolios cost 1.07%, which is cutting your return in half. A GIC ladder might yield about 2% but you get to keep all of that because there’s no MER. That’s a compelling argument for your first suggestion.

  26. Oldie January 8, 2013 at 6:41 pm #

    @CCP: This is a conundrum that has puzzled me: Couch Potato Wisdom tells us that you can’t predict the future, so predicting what interest rates will be in the future is futile. However you actually said “trying to predict THE DIRECTION on interest rates is just guessing”(emphasis mine). I detect a wedge of difference in my initial statement and yours that I quoted. With interest rates so low right now, having declined slowly over the past decade or so, confounding experts who have confidently predicted imminent rise in rates throughout this period (and thereby reinforcing the Couch Potato’s agnostic stance!) is there a point where we can make new, accurate and useful predictions that do not violate the Couch Potato rule? My point is that with interest rates so low now, there is hardly room to decline further without getting into negative values, which I understand is an economic impossibility.

    Therefore, would it not be accurate to say that the rates may increase, or they may stay level and low, but further decrease is a possibility that can be ruled out. This is a new, and I think accurate prediction. The “useful” attribute to my prediction is the one I am puzzling over. In trying to answer my own question , my thinking would go like this: The Couch Potato believes that the market is transparent. Therefore, my prediction, such as it is, that the prevailing interest rates can’t drop significantly further (which would raising the bond values) has already been digested by the market and factored into bond prices, presumably reducing the current prices. Likewise, the significant but not definite possibility that interest rates may rise soon, has already been factored into bond prices, so investing in long term bonds is not necessarily sheer folly as the conventional wisdom would seem to indicate. Your analysis of my logic would be refreshing.

    As you may guess, I’m trying to decide the extent and duration of my Bond component in the context of the present situation, and I’m torn with the realization that, to some degree, I’m trying to time the market, a Couch Potato no-no. Perhaps I should pretend I don’t know what interest rates are today, and where they have been for the past 10 years, and just build a rational mix for all time, like I’m supposed to. You have my permission to talk to me as a Couch Potato Guru, and then as a real live person with the same human fears and frailties as the rest of us :)

  27. Canadian Couch Potato January 9, 2013 at 12:54 am #

    @Oldie: It seems fair to say that interest rates are more likely to up than down. But as you point out, they could also stay low for a long time (just ask a Japanese investor). Given that the future path of interest rates is unpredictable, the only thing investors can do is choose a duration appropriate to their time horizon (no 20-year bonds if you need the money in 10 years, for example) and decide how much volatility they are willing to endure.

    I don;t think it makes sense to pretend you don’t know what interest rates are. There is nothing wrong with acknowledging that bond yields are extremely low today and that it is next to impossible for the returns of the last 30 years to be repeated.

  28. Jas January 9, 2013 at 7:00 am #

    @Oldie:
    The main reason why most people include bonds in their portfolio is to lower the volatility. Over the long term, equities usually, but not always, outperform bonds, but that’s not a reason to exclude bonds from your portfolio. The % of bonds in your portfolio depends on your risk tolerance (aka volatility tolerance).

  29. bettrave January 9, 2013 at 8:13 am #

    Thank you for answering.
    I would have bought a short term index bonds, but ING streetwise doesn’t offer that.
    At first, I wanted to open an account with Disnat and buy ETF, but, thanks to you, since I don’t have 50,000$ to invest and I’m already a ING customer, I decided to go with their streetwise index funds.
    Maybe, I’ll bought two different streetwise funds.
    The equity growth (without bonds) and the balance growth.
    I’ll balance the two funds with GIC and saving accounts to equal about:
    – 28% GIC + saving account
    – 9% Canadian bonds
    – 27% Canadian equity
    – 18% US equity
    – 18% international equity
    One reason why the GIC/saving is high beacause it’s my emergency money (about 2500$).

  30. Oldie January 9, 2013 at 11:22 am #

    @Jas and @betrave: I understand the concept of the cash+bond portion damping volatility. What I was trying to understand was, within this (cash+bond) portion, the calculation of the cash:bond ratio. Now betrave needs to have 28% immediately available, and he doesn’t know when, so it make sense to have that 28% in GIC/saving. (Actually, I just realized GIC’s have a term which prevents you from getting your money out before then — or do you just forfeit the interest?) Ignoring for now the fact that he wants this portion available for withdrawal, is the fact that the bond ratio is so relatively low partly due to the fact that currently, it is unlikely for bonds to make a profit for the next 10 years? If he didn’t have any emergency needs, even in this economic climate, could the whole cash+bond 36% portion be reasonably dedicated to bonds? Why have any bond content at all ( i.e all GIC/interest)?

  31. Rob T March 1, 2014 at 4:46 pm #

    It has been commented that low volatility strategies are really just accessing the value premium. However, far from being value oriented, morningstar describes ZLB’s style as having a growth tilt. How can this be?

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