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. They identified 10 broadly diversified ETFs (as opposed to the dozens of narrowly focused products in their lineup), gave them new names to stress their role as the building blocks of a long-term portfolio, and lowered their costs. At the time a prominent observer noted that iShares had to make a move because it had been “a bit out of the game.” They were losing assets to Vanguard, Schwab and other providers who were undercutting them on fees.
You could say the same thing about BlackRock’s Canadian ETF lineup, which was in danger of becoming obsolete. iShares used to have the market all to itself, and at the end of February they still held about two-thirds of all ETF assets in Canada, but its competitors have been steadily eroding that market share. According to the Canadian ETF Association, Vanguard boosted its assets under management by $310 million in the first two months of this year, while BMO added $215 million. BlackRock, meanwhile, saw net outflows of $512 million, at least partly because the relatively high management fees on some of its older ETFs were increasingly hard to justify.
With the creation of the Core Series, however, iShares is now the the cost leader in several major asset classes:
- Canadian equities: XIC is now one of the cheapest ETFs in the country, with an annual cost of one shiny nickel per $100 invested. The BMO S&P/TSX Capped Composite (ZCN), which tracks the same index, carries a fee of 0.15%, while the similar Vanguard FTSE Canada All Cap (VCN) comes in at 0.12%.
- US equities: XUS now has a lower fee than the virtually identical BMO S&P 500 (ZSP) and Vanguard S&P 500 (VFV), both of which charge 0.15%. BlackRock also lowered the fee to 0.10% on XSP, the hedged version of its S&P 500 ETF.
- International equities: The total-market ETFs covering developed and emerging markets (XEF and XEC) now have lower fees than the Vanguard FTSE Developed ex North America (VDU) and the Vanguard FTSE Emerging Markets (VEE), which track similar indexes. BMO’s offerings in international equities are even less competitive on fees, though the recently launched BMO MSCI EAFE Index ETF (ZEA) does have a more tax-friendly structure.
- Bonds: The iShares High Quality Canadian Bond (CAB) is now the cheapest broad-based bond ETF, sharply undercutting the BMO Aggregate Bond (ZAG) and the Vanguard Canadian Aggregate Bond (VAB), which carry management fees of 0.20%.
A few question marks
The choice of CAB as a Core product is surprising: one might have expected the Core bond ETF to be the iShares DEX Universe Bond (XBB) instead. The granddaddy of fixed-income ETFs has an MER of 0.33%—much higher than its competitors—and is a prime candidate for a fee reduction.
In an interview, Mary Anne Wiley, Head of iShares Canada at BlackRock, explained the choice: “We’re building this for the future, but we’re mindful of who is there today, and what they’re looking for. That fund [XBB] is $1.5 billion, and a lot of investors are there for different reasons. Some are buy-and-hold, but others are using it to position their bond portfolio in a way that is more short-term in nature. Institutions are using that fund, and they’re valuing a couple of different things” other than low MER, such as liquidity and trading volume.
There’s nothing wrong with using CAB as a core bond holding so long as investors understand it. Until recently it was one of iShares “Advantaged” ETFs, which used a complicated structure to recharacterize interest income in a tax-friendly way. When the federal government cracked down on these structures, CAB became a traditional bond fund with 60% government and 40% corporate bonds, all investment-grade. By contrast, ZAG holds about 30% corporates, and while VAB holds just 20%, so the iShares fund has a higher coupon and slightly lower duration, but also a bit more risk.
There are a few oddball choices in the Core lineup: the iShares S&P/TSX Equity Income (XEI) holds 75 Canadian dividend stocks, which I would not even consider a discrete asset class. The iShares Canadian Short Term Corporate + Maple Bond (XSH) is also too specialized to qualify as a core fixed income holding. (A maple bond is issued in Canadian dollars by a foreign corporation.) Rounding out the Core list is the iShares DEX Long-Term Bond (XLB), which is likely to have more appeal for institutional investors. Wiley suggests these three Core fixed income ETFs can be combined to achieve whatever duration investors want in their portfolio.
Itching to switch
Whenever there’s a new product launch or a fee reduction like this, I get a wave of emails from investors who are itching to sell their current holdings to embrace the new ETFs. (Then they ask if I plan to change the recommendations in my model portfolios.) I remind them to keep cost reductions in perspective: low MERs are wonderful, but small differences are often trivial, especially when weighed against transaction costs.
Say you have a $20,000 holding in the Vanguard FTSE Canada All Cap (VCN) and you want to switch to XIC to save 0.07% in management fees. That works out to an annual savings of just $14. If you make two trades at $10 apiece and lose another $10 or $12 on the bid-ask spreads it would take more than two years to break even. If you’re investing in a taxable account and sitting on a capital gain, switching makes even less sense.
It will be interesting to see how Vanguard and BMO respond to this move. But even if the ETF providers call a truce in the price war it’s fair to say Canadian investors are finally getting access to enjoy the pricing that our neighbours in US have enjoyed for many years.
@Steve
Thanks for the input, much appreciated.
My current TFSA size is ~32k, and ~16k in my RRSP. Do you think that would be large enough to go with ETFs, or should I wait until my TFSA reaches ~50k+?
I guess I could always grow my TFSA near a 50k size, and then at that point check up on XUS/XEF/XEC.
Once again, thanks for the input, I’ll have to rethink what I plan to do.
@ Kerplar:
I’ll put it this way: the weighted MER of the 5 ETF portfolio you proposed is roughly 0.14% (adjusting the new management fees for taxes). An equivalent portfolio using 4 TD eFunds with the same asset allocation (but splitting your 10% in emerging markets equally between US and EAFE) has a weighted MER of about 0.42%.
On a $50,000 portfolio, that works out to a difference of about $140/ year in MER (by way of comparison, you’d already be saving $875/ year just by moving from your existing high cost fund to that eFund portfolio!).
Keep in mind you won’t capture all of that $140 differential: even if you get commission free ETF trades, you’ll still have a transaction cost every time you invest new money, or reinvest distributions, or sell to rebalance, in the form of the spread on the shares of each ETF. There is no spread on transacting eFund units, of course.
Since you will be juggling a portfolio between RRSP and TSFA accounts, you should carefully read Dan’s column from February: “The True Cost of Foreign Withholding Taxes” (and the comments following). The tax efficiency of your fund/ ETF allocation between accounts will likely have a bigger impact on your after-tax investment returns than a few basis points of MER here or there (particularly given your large foreign allocation).
Finally, I’m curious about the rationale for the relatively high 55% foreign exposure of your proposed asset allocation (and there may well be good reasons for it)?
@ Steve:
Thanks for the information thus far, I will definitely go back and read the CCP post from February.
There’s no justification for the 55% foreign exposure, other than I wanted to create an allocation that didn’t have 40% bonds, as I’m still young and willing to expose myself to more risk for larger gains. So I basically just spread the 20% I was taking out of bonds evenly across the other 4 funds I originally posted in my first comment.
If I were to go with the iShare portfolio, would it make more sense to go say 40% into XIC, 30% into XUS, and then split the remaining 10% between XEF and XEC. This would just be hypothetical and for learning purposes, I’m looking into what you have suggested already, and I’m more than likely at this point going to to the eSeries funds instead.
The foreign allocation that makes sense for you is the one that meets your needs and you’re comfortable with – there’s no “perfect” or “best” allocation across the board … And yeah, I know that’s a fairly useless comment if you’re looking for feedback on your decision!
If it helps, when I set up our DIY indexed portfolio many years ago, I decided on our foreign equity allocation in a 2 stage process that may not have been the best or most theoretically rigorous way going, but had the benefit of breaking the decision-making process down into distinct, explicit steps:
1) Determine an overall “foreign” allocation as a single % across the entire portfolio. As a guide, Canadian pension plans currently seem to hold on average a bit under 30% of their portfolio in foreign equities, with some more in foreign bonds and real estate, for an overall foreign allocation of 35-40%.
That’s a reasonable starting point, and you can adjust from there to reflect personal constraints.
(Don’t be distracted by the reference to foreign bonds and real estate – those asset classes may only be relevant, if at all, when your portfolio is much larger)
2) Think of your overall “foreign” content as a 100% mini portfolio and allocate it across equity asset classes (we only hold total market indexes, or as close as possible, so we don’t break out “small cap” or “value” foreign equity).
One method is by relative world market cap ex-Canada, so that (for example, using rough figures) US = 45%, EAFE = 40%, Emerging Markets = 15%. Another popular and even easier way is to allocate half to the US, then split the other half 2/3 to EAFE, 1/3 to Emerging Markets (these 2 methods actually result in quite similar allocations!).
Again, you can adjust these allocations as needed to take account of personal constraints.
So as an example – using hypothetical numbers – if your foreign allocation is 30%, and you choose the “easy” method, your foreign equity would be 15% US, 10% EAFE, and 5% Emerging Markets. Taking (for example) your 20% bond allocation as given, that would imply the remaining 50% of the total portfolio allocated to Canadian equity.
Hello.
I noted your comment on not updating your model model portfolios. Wouldn’t it be worth it for those who have yet to take action towards the couch potato approach with ETFs? I totally understand it may not be worth it to switch, but for those about to exit mutual finds and enter ETFs it would be really nice to have the “best” options all in one place. My registered portfolio (~350k) is a mess of various ETFs (iShares), eSeries Funds, individual stocks, and cash. I am planning to do a 6 year overdue re-balancing and plan to embrace the Complete Couch Potato. I suppose I might as well try and find the cheapest options.
Thanks for all the research!
@RW: Investors are always free to chose whatever ETFs they feel are appropriate for their situation. The model portfolios are designed to be starting place for people who are confused by all the choices available. I could easily create versions using all iShares, all BMO or all Vanguard products and I would expect the performance to be almost identical over the long run. But I’ve found it’s more helpful to give a single good recommendation rather than presenting investors with many good choices.
The other point is that “best” doesn’t always mean “cheapest.” Just because an ETF is cheaper than one in my model portfolios does not mean I would recommend it. For example, I like the broader diversification of VUN for US equities even though XUS is now a bit cheaper. And CAB is 40% corporate bonds, compared with only about 20% for VAB, so the risk decision is far more important than the difference in MER.
Just a quick note, the CAB fund appears to be listed as XQB, I’m not sure when the symbol changed, but if you could update the article it could clear up any confusion if people go looking for CAB.
@Patrick: The fund changed its ticker in symbol in July, about four months after this blog post was published. I don’t usually go back and change outdated posts: it would be impossible to keep up. The links still take you to the right fund.
err I was looking at these on RBC’s direct investment website and the quotes all showed MERs that seemed off, this post explains it, it seems they haven’t updated yet, it still shows a MER of 0.27% for XIC, not sure why it is off by 0.02% though. Similar story with VCN.
@Taal: The extra couple of basis points is usually due to taxes. Don’t forget that “management fee” and “MER” are not synonymous. MER is management fee plus taxes (which are usually about 10%, or 2 bps on a 0.20% fee).
Hi ! I’m new to the investment world. I’m a young physician (31) who wants to get involved with passive investing in my corporate account. My husband and I both have small RRSPS (25k each) and we have 200k in the corporation that we would like to invest in ETFS. I was planning to invest 100k in XIC and 100k in XUS and then in our RRSP do 50k in XBB (75% equity / 25% fixed income). I was hoping for more of a 70/30 or 65/35 split between equity and fixed income but having almost all of our money locked in the corporation is making this tricky! I also wanted to buy some XRE as well but I’m not sure this would be tax efficient in the corp? Any suggestions or reading material regarding corporation investing would be appreciated!