Archive | December, 2012

Ask the Spud: Do I Have Enough for a DRIP?

Q: I’m planning to use my 2013 TFSA room to purchase a bond ETF. How can I make sure I’m investing enough to benefit from a dividend reinvestment plan? – Phil B.

Dividend reinvestment plans (DRIPs) are a convenient way to make sure your money is compounding every month rather than sitting idly in your account. When you sign up for a DRIP, your distributions (whether dividends, interest or return of capital) are paid in new shares rather than in cash. Discount brokerages typically offer DRIPs for just about all Canadian ETFs, and you can arrange them with a simple phone call or email to the customer service desk.

The potential problem with DRIPs, however, is you can’t receive fractional shares: each distribution must be large enough to purchase one full ETF share, or it will just be paid in cash. Now that more ETFs are paying distributions monthly (as opposed to quarterly, which used to be the norm), each payout is small and you need a fairly significant holding before you’ll receive even a single new share with every distribution. But exactly how much do you need?

It’s not possible to calculate this amount precisely,

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What Investors Can Learn From Weather Forecasts

I’ve never made a secret of my opinion that acting on market forecasts is destructive to investors. Nate Silver’s fascinating new book, The Signal and the Noise: Why So Many Predictions Fail—But Some Don’t includes some telling examples from the world of finance, but he drives home this idea even more forcefully with his insights about the weather.

Silver explains that meteorological forecasts are quite accurate if they’re made just a few days in advance, but the further out you go, the less helpful they become. Forecasts made eight days in advance are useless, and beyond that they’re actually harmful: “They are worse than what you or I could do sitting around at home and looking up the table of long-term weather averages,” Silver writes. Yet despite being aware of this evidence, The Weather Channel and AccuWeather make forecasts for 10 days and 15 days into the future, respectively.

The book also describes how for-profit weather services are more concerned with the perception of accuracy than with accuracy itself. This gives them an incentive to be bolder than they should be. If their models forecast a 50% likelihood of rain,

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A Market Forecaster’s Report Card

As 2011 came to a close, the usual army of market gurus began making predictions for 2012. I’ve often criticized market forecasters for their embarrassing track records, so this year I made a point of saving a few articles so I could see how accurate their crystal balls would turn out to be.

The first one I bookmarked was called 10 market predictions for 2012—and how to profit from them, in The Globe and Mail. The guru is a portfolio manager for the GMG Defensive Beta Fund, based in New York. Let’s see how accurate his calls turned out to be, and whether you should have acted on them.

1. The S&P 500 will rise by at least 10%.

This probably seemed wildly optimistic a year ago, but it was correct. In fact, the S&P 500 is up about 16% so far in 2012. Unfortunately, the tactical advice was less helpful: “If you have a lot of conviction this prediction will come true, you might consider buying the Russell 1000 High Beta ETF. If you think the election will work its magic,

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How Much Are You Paying For US Dollars?

Currency conversion remains one of the biggest rip-offs in banking and investing. It’s made worse by the lack of transparency: if you call your discount brokerage they’ll quote their current rates, but it’s still hard to calculate the actual cost of your transaction. Don’t expect your brokerage to help with the math.

The first key point is, in practical terms, there isn’t a single exchange rate. While we might say “the US and Canadian dollars are at par,” that’s never quite true. On a day when the two currencies are theoretically equivalent, it might cost you $1.01 CAD to buy $1 USD, and if you sell $1 USD you might receive $0.99 CAD. That’s because currencies have a bid-ask spread just like stocks and ETFs that trade on an exchange.

There’s a simple formula to calculate the size of the bid-ask spread in percentage terms:

= (Ask Price – Bid Price) ÷ Ask Price × 100

Note that the bid price is always the lowest of the two rates you’re quoted. So if we plug in the numbers in the example above, the math works like this:

= (1.01 – 0.99) ÷ 1.01 × 100
= (0.02) ÷ 1.01 × 100
= 0.0198 × 100
= 1.98%

The bid-ask spread in this example works out to 1.98%,

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Ask the Spud: Adding a New REIT to the Index

Loblaw recently announced it will be creating a new real estate investment trust (REIT). Once it goes public, how would it be added to existing real estate ETFs? And considering how large the proposed REIT will be, what effect might it have on ETF shareholders? – Joel H.

On December 6, Loblaw Companies announced it would be turning its vast property holdings into a REIT in the new year. Units in this new trust will be listed on the Toronto Stock Exchange and sold during an initial public offering (IPO) in mid-2013.

Any time a new company is listed on the TSX, it may be considered for inclusion in any number of indexes. For example, stocks in the S&P/TSX Composite Index must meet certain criteria (mainly size and liquidity). The index is reviewed every quarter, and if a company no longer meets these criteria it can be removed. By the same token, any newly listed company that does fit the criteria can be added to the index.

The new Loblaw REIT will be one of the largest in Canada, so it will likely qualify for inclusion in the Composite index.

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Passive Investing: The Movie

There are countless books laying out the case for index investing, but as far as I know there has never been a film—until now. A UK investment firm has just released a 54-minute documentary called Passive Investing: The Evidence, which includes cameos from some of the leading proponents of strategy.

The film was financed by Barnett Ravenscroft Wealth Management, which manages portfolios using products from Dimensional Fund Advisors and Vanguard, so they clearly have a vested interest in promoting the strategy, but it would be unfair to dismiss the film as an hour-long infomercial. BRWM works only with individuals and institutions who have over £1 million in investable assets, yet the company seems eager to get its message out to the UK public, even though the vast majority of the film’s audience will never become clients.

They’ve certainly made a significant investment in the film: the production quality is very high and the interviews include luminaries such as John Bogle, Charles Ellis, Rick Ferri, Kenneth French, William Bernstein, Burton Malkiel and William Sharpe. Not since Toy Story have so many potatoes appeared in one film.

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Ask the Spud: Combining e-Series Funds and ETFs

I use the Global Couch Potato with e-Series funds in my TD Waterhouse account, but I eventually want to use the Complete Couch Potato. Once my portfolio gets to $50,000 and I qualify for $9.95 trading commissions, should I move everything to ETFs? — Mark V.

If you’re a client of any other brokerage, it makes sense to use ETFs to build the Complete Couch Potato portfolio. But with TD Waterhouse you have the unique opportunity to combine the e-Series mutual funds and ETFs in the same account. For five-figure portfolios (and perhaps even much larger accounts) a hybrid approach is likely to make more sense than using all ETFs.

The Complete Couch Potato has three asset classes that are absent in the Global Couch Potato: real estate, real-return bonds, and emerging markets. There are no e-Series funds for these asset classes, nor are there low-cost index funds from other providers. But that doesn’t mean you can’t create a hybrid portfolio of e-Series funds and ETFs. It would look something like this:

Asset class
 %

Fund name (ticker)
MER

Canadian equity
20%

TD Canadian Index – e (TDB900)
0.33%

US equity
15%

TD US Index – e (TDB902)
0.35%

International equity
10%

TD International Index – e (TDB911)
0.50%

Emerging markets equity
5%

Vanguard MSCI Emerging Markets  (VEE)
0.55%

Real estate
10%

BMO Equal Weight REITs (ZRE)
0.62%

Real return bonds
10%

iShares DEX Real Return Bond (XRB)
0.39%

Canadian bonds
30%

TD Canadian Bond Index – e (TDB909)
0.51%

100%

0.45%

A few words of explanation.

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Inside the iShares Minimum Volatility ETFs

Last week we looked at two low-volatility ETF strategies based on beta and the standard deviation of daily price movements. Now let’s complete our roundup by looking at a third methodology used by MSCI, the index provider behind the new iShares family of low-volatility ETFs. This is one is completely different from the other two.

MSCI’s strategy is based on creating what’s called a minimum variance portfolio, an idea that goes back to Harry Markowitz’s Modern Portfolio Theory in the 1950s. What makes this strategy unique is that the individual companies don’t matter much in isolation, or even relative to the market as a whole. What’s important is their correlation with each other: the goal is to combine stocks in a way that results in a portfolio with the lowest possible volatility. Think of it like a cake recipe where you add baking powder and salt—which can be unpleasant on their own—because they taste delicious when combined with the other ingredients.

The methodology starts with a parent index that represents the broad market—such as the MSCI Canada Index—and then applies a number of rules to optimize that portfolio.

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