Archive | March, 2014

iShares Cuts Its Fees to the Core

That sound you just heard was the latest shot fired in Canada’s ETF price war. iShares has just slashed the management fees on several popular equity and bond ETFs—and just like that the country’s oldest ETF provider has become the cheapest in many categories.

BlackRock has rebranded nine ETFs as the iShares Core Series, “a suite of funds covering key asset classes.” A balanced portfolio of these ETFs now has a weighted management fee of just 0.12% or so, less than half the former cost. (As a rule of thumb, expect the full MERs to be 8% to 10% higher due to taxes.) Here’s what a traditional Couch Potato portfolio might look like when assembled from the Core Series ETFs:

ETF name
Allocation
Old fee
New fee

iShares S&P/TSX Capped Composite (XIC)
20%
0.25%
0.05%

iShares S&P 500 (XUS)
20%
0.14%
0.10%

iShares MSCI EAFE IMI (XEF)
15%
0.30%
0.20%

iShares MSCI Emerging Markets IMI (XEC)
5%
0.35%
0.25%

iShares High Quality Canadian Bond (CAB)
40%
0.30%
0.12%

Total
100%
0.26%
0.12%

The cost of competition

BlackRock launched a family of Core iShares ETFs in the US back in October 2012.

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When the Smart Money Does Dumb Things

Investors can a learn a lot from pension funds, particularly when it comes to diversification, risk management and long-term thinking. But it seems professional money managers are not immune from the behavioural challenges that plague retail investors.

Doug Cronk, who writes a useful blog called Institutional Investing for Individual Investors, recently pointed me to a couple of industry articles that make it clear the pros are just as human as the rest of us. (I interviewed Doug last fall for an article called “Invest like a pension fund manager” in Canadian Business.)

In a February article in Pensions & Investments, a strategist explains that many pension funds have an investment plan that calls for them to increase their allocation to bonds when their plan is well funded. This is what investors might call “taking risk off the table”: the idea is that if equity markets have been strong and you believe you’re comfortably on track to meet your goals, you can afford to reduce the risk in your portfolio. However, the strategist says many fund managers are reluctant to carry out this plan: “According to their glidepath they should be starting to shift asset allocation now,” he says.

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How Pension Funds Think About Bonds

With the bond market up about 3% year-to-date, the bears have been growling less than usual. But I still get a steady stream of email from readers who think bonds “make no sense anymore” because they have low yields and will fall in value if interest rates rise. However, if you’re a pension fund manager your opinion of bonds is probably different.

Before we go further, let’s acknowledge that a pension fund isn’t the same as your RRSP. Institutional investors have an indefinite time horizon, as well as access to far more investment options than you and me. Yet retail investors can learn a lot from the smart money like the managers of the Healthcare of Ontario Pension Plan. (Hat tip to Raymond Kerzérho, director of research at PWL Capital, for pointing me to the HOOPP strategy.)

It’s not about the income

HOOPP uses what it calls a “liability driven” investment approach, which involves constructing two separate portfolios with different goals. The first is the Return Seeking Portfolio, and it includes primarily Canadian and international equities, as well as a number of active strategies. The second is called the Liability Hedge Portfolio,

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Why Currency Hedging Doesn’t Work in Canada

In the last two years, Canadian ETF providers have finally launched US and international equity ETFs that do away with currency hedging. Yet the strategy remains hugely popular: the hedged versions of Vanguard’s international and US total market ETFs remain much larger than their unhedged counterparts, while investors have more than $2 billion in the iShares S&P 500 Hedged to CAD (XSP), making it the third largest ETF in Canada.

None of my model portfolios include currency-hedged funds: I’ve long argued the strategy is expensive and imprecise. Even when the Canadian dollar appreciates strongly, the high tracking error of currency-hedged funds often reduces any potential benefit. In one dramatic example, Justin Bender looked at the period from 2006 through 2011, when the US dollar depreciated by almost 13% and hedging should have produced a huge boost: in reality, XSP lagged its US-listed counterpart.

This leads to an interesting question. If currency hedging were free and precise—with an expected tracking error of zero—would it be worth considering?

Does hedging lower volatility?

The most common argument in favour of currency hedging is that it lowers volatility.

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iShares Advantaged ETFs: Where Are They Now?

Before being bought by BlackRock early in 2012, Claymore Investments pioneered many new services and unconventional products. One of these was its so-called Advantaged ETFs, which used a complicated structure to convert fully taxable bond interest and foreign income into tax-favoured return of capital and capital gains.

Barely a year after these funds joined the iShares family, the 2013 federal budget took aim at this sleight of hand. While the government is grandfathering contracts already in force, it won’t allow new ones, which means the eventual end of the tax break promised by the Advantaged ETFs. A couple of weeks after the budget, iShares stopped accepting new subscriptions for these funds until they decided how to handle the situation.

The ETFs are open for business again, but several have new names and all have new strategies. Here’s a summary:

The iShares Global Monthly Advantaged Dividend has become the Global Monthly Dividend Index ETF (CYH). The tax-favoured structure is gone, but the investment strategy is largely the same: the fund is about half US and half international dividend stocks. However, the older version used two US-listed Guggenheim ETFs as its underlying holdings.

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