Archive | June, 2013

The Wait is Over: New ETFs From Vanguard

“Ask and ye shall receive.” That should be the refrain of Couch Potato investors during the last 10 months or so as the industry has filled just about all the gaps in the ETF marketplace.

First it was the flurry of S&P 500 ETFs without currency hedging: Vanguard, BMO, iShares and Horizons have all launched one since October. Then iShares brought out a pair of broadly diversified international equity ETFs, also without the hedging. Now Vanguard Canada has announced a new suite of ETFs that includes a few we’ve been eagerly awaiting.

Vanguard filed the preliminary prospectus for these new ETFs on June 19, and since new products typically appear about 90 days later, at least some should start trading by the end of summer.

First there’s the long-awaited Vanguard U.S. Total Market, an unhedged version of VUS. Its underlying holding will be the US-listed version of this fund, the Vanguard Total Stock Market (VTI), a core piece of my Complete Couch Potato.

While the fees for the new ETFs haven’t been announced,

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Is One Index Really Better Than Another?

Couch Potato investors try to capture the returns of entire asset classes rather selecting individual securities. And we do that with passively managed funds designed to track indexes that represent each of those asset classes. But which index, exactly?

Since Vanguard announced last fall that it would be ending its relationship with the index provider MSCI, the question is worth considering. Vanguard’s Canadian equity ETF, for example, was originally benchmarked to the MSCI Canada Index but now tracks the FTSE Canada Index. Can investors expect the fund to behave differently now?

The short answer is yes, but the full story is more subtle: if the past decade is any guide, the performance of the two indexes will vary from year to year. But the differences are likely to be the result of random noise, and neither of these benchmarks can be said to have any meaningful advantage over the other.

There’s more than one way to measure the market

Investors often refer to “the index” the same way they refer to “the dictionary.” But in both cases, the definite article isn’t really appropriate: there isn’t a single authority.

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Two Core ETFs Get New Indexes

Vanguard announced last October that it would be ending its relationship with MSCI, one of the largest index providers in the world, and using new benchmarks for many of its most popular ETFs. That transition is now complete. Between January and April of this year, Vanguard Canada’s emerging markets equity, Canadian equity, and international equity ETFs all got new indexes created by FTSE. And earlier this month Vanguard changed the benchmark for two US-listed ETFs that happen to be core holdings in my Complete Couch Potato portfolio.

The Vanguard Total Stock Market (VTI) is now benchmarked to the CRSP US Total Market Index rather than the MSCI US Broad Market Index. The Canadian-listed version of this fund, the Vanguard US Total Market Index (VUS), simply holds VTI and adds currency hedging, so it is affected by the index change as well.

Don’t expect any meaningful effect on the performance of VTI. The CRSP index is slightly broader than its MSCI counterpart: the latter “targets for inclusion 99.5% of the capitalization of the US equity market,” while the former “represents approximately 100% of the investable US stock market.” That means the CRSP index will include more micro-cap stocks,

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ETF Investors: Avoid the After-Hours Club

One of the first rules of buying and selling ETFs is to always use limit orders, never market orders. A limit order allows you to specify the maximum price you’re willing to pay, or the minimum you’re willing to accept. By setting this limit a couple of cents above the ask or below the bid you ensure you won’t be surprised by a sharp move in the markets or a pricing anomaly.

That message seems to be well understood, but a related issue has come up a few times with clients of our DIY Investor Service. We’ll be working with a client who has a nine-to-five job, and when it comes time to implement the portfolio he’ll ask whether we can make the trades in the evening, after the markets have closed. Wouldn’t the orders just be filled the next day after the opening bell, he’ll ask? They might, but you may not like the results.

Prices that go bump in the night

It’s quite common for companies and governments to make important announcements in the pre-market or after hours, which may causes price of securities to open sharply higher or lower than their previous closing price.

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It’s Time to Ban Advisor Commissions

Should financial advisors be banned from collecting commissions on mutual funds? That’s been hotly debated for years, and in December the Canadian Securities Administrators (CSA) issued a discussion paper that considered the idea of imposing such a ban. Australia already did so in 2012, and the U.K. followed suit this January. But if it ever comes to pass in Canada, it would happen despite a strong lobby by Advocis, the Financial Advisors Association of Canada. And that’s a shame.

This week the chair of Advocis sent an email to advisors that started like this:

Every day your clients rely on you to help them achieve their financial goals. If you’re like me you depend on commissions to make your advice possible. How would you survive if there were no commissions? As strange as it may seem, that is the intent behind the recent consultations by the CSA regarding fees — including a ban on embedded commissions.

While this is currently limited to mutual fund trailers and DSC fees, there is no structural difference with life insurance commissions.

The way we do business is under unprecedented threat.

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What’s Happening to My Bond ETF?

If your portfolio includes a broad-based bond index fund, you’ve probably noticed its value has fallen significantly over the past several weeks. Judging from recent e-mails I’ve received, the reasons for this decline are not always clear, so let’s take a closer look.

Most investors understand that when interest rates rise, bond prices fall. But there are many different interest rates, and they all affect your bond fund in different ways. The shortest of short-term rates is the target for the overnight rate, which is set by the Bank of Canada to control monetary policy—in other words, to keep inflation low. This rate influences the prime rate banks use to price variable-rate mortgages and lines of credit, so it’s the one most widely discussed in the media.

The Bank of Canada has kept the target rate at 1% since September 2010: that’s more than 32 months, the longest period it has ever remained unchanged. Meanwhile, the prime rate has held firm at 3% during this same period. I’ve been asked by some investors why they’ve seen their bond holdings fall when “interest rates haven’t gone up.”

But as I’ve mentioned,

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Why Use a Strip Bond ETF?

Barry Gordon admits he was surprised when he first read Justin Bender’s entry in First Asset’s Search for Canada’s Next Top ETF contest, which I introduced in my previous post. “It runs against the grain of everything we thought we knew about strip bonds,” he says. But Gordon’s firm turned the idea into the First Asset DEX 1-5 Year Laddered Government Strip Bond Index ETF (BXF), which begins trading next Tuesday. Here’s an overview of this innovative new index fund, as well as an explanation of how it might be used in a portfolio.

Inside the ETF

First Asset tasked PC-Bond with creating the index for their new strip bond ETF. Here’s the basic methodology:

the ladder will have “term buckets” with bonds of approximately one, two, three, four and five years to maturity
each bucket will include five individual strip bonds: four provincial (mostly issued by Ontario and Quebec) and one federal (or federal agency)
the bonds will be selected with liquidity in mind: the issues must be at least $50 million and will be screened for maximum trading volume
the index will rebalance annually in June: bonds with less than one year to maturity will be sold and the proceeds used to purchase new bonds for the five-year bucket

No surprises so far.

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A New ETF of Strip Bonds

Back in February I asked readers to share their ideas for new ETFs that might fill gaps in the current marketplace. The idea for that blog post came from a contest run by First Asset, who invited advisors to submit their suggestions and promised to launch a new product based on the best idea.

I offered a couple of my own: an international equity ETF that doesn’t use currency hedging, and an international bond ETF. As it happens, iShares answered the first call in April with the launch of the MSCI EAFE IMI Index ETF (XEF), which I wrote about here. Vanguard listed an international bond fund in the US last week, though this isn’t suitable for Canadian investors who want to avoid currency risk with their fixed income.

Justin Bender strips for charity

The winning suggestion turned out to be more innovative than either of these ideas, and it came from none other than my colleague Justin Bender at PWL Capital. The new ETF, which will launch on June 11, is called the First Asset DEX 1-5 Year Laddered Government Strip Bond Index ETF (BXF).

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