Archive | 2013

The Failed Promise of Market Timing

I’ve long believed the most difficult part of being a Couch Potato investor is resisting temptation. Index investors are asked to be content with market returns, but they are bombarded daily by fund companies, advisors and market gurus who promise more.

Back in May 2012, I wrote about one of these enticing strategies, described in The Ivy Portfolio by Mebane Faber and Eric Richardson. The so-called Global Tactical Asset Allocation (GTAA) strategy grew out of Faber’s widely read research paper, A Quantitative Approach to Tactical Asset Allocation, first published in 2007. It begins with a diversified portfolio inspired by the Yale and Harvard endowment funds, combining traditional and alternative asset classes. The “tactical” part involves using market timing to move in and out of these asset classes based on 10-month moving averages.

Faber updated the paper in early 2013 and it now includes four full decades of data. From 1973 through 2012, the GTAA strategy shows exactly one negative year: a modest loss of –0.59% in 2008. And over those 40 years, the GTAA delivered an annualized return of 10.48% with a standard deviation of 6.99%,

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Why Has VRE Outperformed Its Rivals in 2013?

It’s been a marvellous year for equities, but 2013 has not been kind to real estate investment trusts. Like other income-producing investments, REITs are sensitive to rising interest rates, and the sharp increase in the middle of this year hit them hard. But the three Canadian ETFs in this asset class have shown significant differences in performance. Notably, the Vanguard FTSE Canadian Capped REIT (VRE) has outperformed its iShares and BMO rivals by a wide margin. Here are the year-to-date returns of the funds as of December 18, according to Morningstar:

Vanguard FTSE Canadian Capped REIT (VRE)
–2.47%

iShares S&P/TSX Capped REIT (XRE)
–7.81%

BMO Equal Weight REITs (ZRE)
–6.72%

REISs pieces

Whenever you see variance among funds in the same asset class, it’s important to determine why. In this case, the main reason is a significant difference in the underlying indexes. Shortly after VRE was launched, I wrote a detailed post describing its benchmark, the FTSE Canada All Cap Real Estate Capped 25% Index, which is quite different from those tracked by the iShares and BMO funds.

Like XRE,

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The Powerful Pull of Possibility

If the evidence in favour of passive investing is so strong, why isn’t the strategy more popular? I hear that question all the time, and there are several answers, including effective marketing by investment firms and a general lack of awareness. But there’s another reason that affects even those who are well aware of the research. It’s the deep emotional appeal that comes from the possibility—however small it might be—of achieving market-beating returns.

I thought about this recently during a conversation with an investor who was considering moving from his current advisor (who used a highly active strategy) to an indexed approach. Robert had been with his advisor for more than 10 years, and it was clear his portfolio had lagged the indexes over that period. He also complained the advisor was providing no financial planning and no tax management: there was only active investment management, and it had failed for more than a decade. Why, then, did Robert find it so hard to break free?

As we spoke, the answer became clear: Robert wasn’t disputing that indexing had a higher probability of success. He just wanted to hold onto the possibility of outperformance.

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Ask the Spud: When Should I Use US-Listed ETFs?

Q: Under what specific circumstances would it be better to hold a US-listed ETF if there is a Canadian equivalent? For example, when it is preferable to use the Vanguard Total Stock Market (VTI) rather than the Vanguard U.S. Total Market (VUN)? — R. F.

Until late 2012, there really were no great options for Canadian ETFs that held US and international equities. If you wanted a low-cost, cap-weighted index fund that did not use currency hedging, you were out of luck. That’s why my Complete Couch Potato model portfolio currently uses a pair of US-listed ETFs for its foreign equity components.

But the case for using US-listed ETFs is not nearly as compelling as it used to be. Since April, iShares and Vanguard have launched inexpensive Canadian ETFs covering the broad US and international markets without currency hedging. For example, the Vanguard U.S. Total Market (VUN), launched in August, is virtually identical to the Vanguard Total Stock Market (VTI)—indeed, VUN simply holds units of VTI.

There are three important differences between these ETFs,

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Norbert’s Gambit: The Complete Guide

[This post was updated in February 2015 to reflect recent changes at some brokerages.]

Norbert’s gambit remains the least expensive way to convert Canadian and US dollars at a discount brokerage. For investors looking to buy US-listed ETFs, learning this technique can save hundreds of dollars by sidestepping the wide currency spreads charged by brokerages.

With the 2013 launch of excellent unhedged foreign equity ETFs from Vanguard and iShares, there’s less of an incentive to use US-listed ETFs than there used to be. In fact, in a non-registered account or a TFSA it may not even be worth the added cost and inconvenience if the only difference is a few basis points of MER. But in an RRSP, there’s a significant benefit: using US-listed ETFs can dramatically reduce the impact of foreign withholding taxes, which can add an additional cost of 0.30% to 0.70% to US and international equity holdings.

The problem with learning to pulling off Norbert’s gambit, however, is that there’s no simple set of instructions that works at every brokerage. RBC Direct Investing and BMO InvestorLine both allow you to hold US dollars in registered accounts,

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Pulling Off the Bandage Quickly

Deferred sales charges (DSCs) may have been the mutual fund industry’s greatest marketing innovation. Back in the 1980s, it wasn’t unusual for funds to be sold with front-end loads of 5% or more. Then fund companies realized it’s a mistake to charge an entry fee that discourages people from buying your product. Better to draw them in for free and charge them dearly to leave: DSCs typically start at about 6% and continue on a sliding scale for six or seven years, with no time off for good behaviour.

For investors who have six-figure mutual fund portfolios, the cost of selling funds with DSCs is downright painful: in our DIY Investor Service we have worked with clients who have had to swallow more than $5,000. There are no doubt countless others who want to break free of a bad relationship and start fresh with a low-cost portfolio of index funds, but who just can’t bring themselves to fork over those DSCs. They’d prefer to sell their funds gradually over two or three years in order to reduce the upfront cost.

That’s understandable, but in most cases it’s probably the wrong decision. While there may be ways to make a gradual exit,

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The Hidden Cost of Bid-Ask Spreads

Trading commissions get a lot of attention from ETF investors, and rightly so. But depending which ETFs you use and the size of your trades, the impact of bid-ask spreads may be larger than you thought.

The bid price is what you expect to receive when you sell shares, while the ask price (or offer price) is what you would expect to pay to buy them. The difference between the two is called the bid-ask spread, and it represents the profit taken by the market makers.

Unlike with individual stocks, trading volume doesn’t have a major effect on the bid-ask spread of an ETF. The liquidity of an ETF is largely determined by the liquidity of its underlying holdings: if the fund holds frequently traded large-cap stocks, its bid-ask spread should be very tight even if the ETF itself doesn’t trade very often. If the ETF holds micro-cap stocks or illiquid bonds the spread will be wider even if units trade frequently.

The underlying story

But that’s not the whole story. If the liquidity of the underlying holdings was the only factor, ETFs in the same asset class would have more or less identical bid-ask spreads,

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A Touch of (Corporate) Class

ETFs are generally more tax-efficient than mutual funds, but there is one area where they’re at a disadvantage. Investors who use non-registered accounts can take advantage of corporate class mutual funds, which can reduce or defer taxes. Well, now the country’s newest ETF provider, Purpose Investments, has launched the first corporate class ETFs in Canada.

It’s little surprise the innovation comes from Purpose. The company’s CEO is Som Seif, who founded Claymore Investments back in 2005. Claymore was an ETF pioneer: they were the first to offer pre-authorized cash contributions (PACCs), dividend reinvestment plans (DRIPs) and systematic withdrawal plans (SWPs). Then they teamed up with Scotia iTRADE to offer the first commission-free ETF program. Seif exited Claymore after they were bought by BlackRock in 2012, and it was only a matter of time before he got behind a new project that shook up the ETF business.

Before looking at the new ETFs, let’s review how corporate class funds work. Most mutual funds are structured as trusts. Income flows through to investors and retains its character: in other words,

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Worst Mutual Fund Ad of the Year?

The mutual fund industry loves to sell past performance, and it’s not above massaging the data to make that performance look even better. But every now and then an advertisement appears that sets the bar even lower. Michael Callahan, a financial planner in Ottawa, recently sent me an ad for IA Clarington Investments that might be the worst one I’ve seen yet. “I figured you might welcome an opportunity to rip this one to shreds,” he wrote. Challenge accepted.

First there’s the time frame. The ad says the company believes active managers “can and do persistently outperform over the long-term.” But as explained in the fine print (microscope not provided), the year-to-date returns in the first column of the table are for the period ending March 31, so we’re talking about three months. We get 12-month returns in the second column, and the third column gives the funds’ returns since their inception. Problem is, the three funds spotlighted here were launched in the late summer of 2011, so they had been around for all of 18 to 19 months when these returns were calculated. That might be long-term if you’re an insect,

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