Archive | 2014

An Interview With Wealthsimple: Part 1

Wealthsimple is one of several online investment firms that have launched in Canada this year. They’ve often been referred to as robo-advisors, though they reject that name, and with good reason. While some parts of the process are automated, clients of these new firms do interact with humans, and all the trades are made by a flesh-and-blood portfolio manager.

At Weathsimple, that portfolio manager is David Nugent, and we recently sat down to discuss the firm’s advice model and investment strategy. Here’s the first part of our interview.

The first step in building a client’s portfolio is determining an appropriate asset allocation. How do you do that?

DN: The first step is a 10-question risk assessment clients do online when they sign up for an account. After that they book a call with me—or, as we grow, someone else on our team. We try to get an understanding of their past investing experience and any biases they might have, and then we talk about the asset mix. The real conversation happens over the phone.

Surprisingly, we’re more likely to see people increase their risk level after the phone call.

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Vanguard Makes Its Move

You knew it was coming: Vanguard Canada has dramatically reduced the fees on 11 of its ETFs. The announcement came this week, and it affects some of the most popular funds in the Vanguard lineup:

ETF
Ticker
Old fee

New fee

Vanguard FTSE Canada
VCE
0.09%
0.05%

Vanguard FTSE Canada All Cap
VCN
0.12%
0.05%

Vanguard FTSE Canadian High Dividend Yield
VDY
0.30%
0.20%

Vanguard S&P 500
VFV
0.15%
0.08%

Vanguard S&P 500 (CAD-hedged)
VSP
0.15%
0.08%

Vanguard FTSE Developed ex North America
VDU
0.28%
0.20%

Vanguard FTSE Developed ex North America (CAD-hedged)
VEF
0.28%
0.20%

Vanguard FTSE Emerging Markets
VEE
0.33%
0.23%

Vanguard Canadian Aggregate Bond
VAB
0.20%
0.12%

Vanguard Canadian Short-Term Bond
VSB
0.15%
0.10%

Vanguard Canadian Short-Term Corporate Bond
VSC
0.15%
0.10%

Normally the leader when it comes to low costs, Vanguard actually got scooped by its competitors in Canada this year. iShares slashed fees on several ETFs back in March, and BMO followed up a month later with dramatic cost cuts of its own. In a blog post last spring comparing the core equity ETFs of the three providers I wrote: “Surprisingly, the Vanguard counterparts are now the most expensive in the group.

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How Taxes Can Affect ETF Performance

In our recent white paper, After-Tax Returns, Justin Bender and I introduced a methodology for measuring the effect of income taxes on ETF returns. Justin also created a downloadable spreadsheet you can use to estimate the after-tax returns of funds in your own portfolio.

As we explain in the paper, funds with similar pre-tax returns can look quite different when you compare their performance after the CRA has taken its cut. Remember that on a pre-tax basis investment gains are reported in the same way whether they’re Canadian dividends, fully taxable income or capital gains. If you’re investing in a tax-sheltered account, it’s all the same. But in a non-registered account, distributions are taxed in different ways, and this can dramatically affect the amount of money you actually keep.

Here’s a real-world example that illustrates how large the difference can be. Justin collected the distribution and price data for the iShares Core S&P/TSX Capped Composite (XIC) and the DFA Canadian Core Equity Fund (DFA256) over the nine years ending in 2013. Both funds track the broad Canadian stock market, so you would expect similar returns. And indeed,

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After-Tax Returns on Canadian ETFs

When you invest in a non-registered account, you need to be concerned about more than just your funds’ performance: you also need to know how much of your return will be eaten up by taxes. Unfortunately, while regulators are strict about the way ETFs and mutual funds report performance, fund companies in Canada have no obligation to estimate after-tax returns—something that’s been required in the US since 2001.

To help address this problem, Justin Bender spent the last several months creating a calculator for estimating the after-tax returns on Canadian ETFs. He was inspired by Morningstar’s US methodology, but he made many significant changes to adapt it for Canada. The new methodology is fully explained in our latest white paper, After-Tax Returns: How to estimate the impact of taxes on ETF performance. We have also made our spreadsheet available for free download so DIY investors can experiment on their own. (The spreadsheet is protected so the formulas cannot be altered. However, we have included detailed descriptions of these formulas in the appendix to the white paper.)

The methodology is quite complex, but here’s an overview in plain English:

We begin by recording the ex-dividend dates for all the cash distributions an ETF made during the period being considered.

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Is It Time for Tax Loss Selling?

Last October, Justin Bender and I published a white paper on tax loss selling with ETFs. It explained how index investors can harvest capital losses while maintaining a consistent exposure to the equity markets. We were proud of the paper (which was even adapted as a continuing education course for advisors) but it proved to be rather useless during the subsequent year. Indeed, it would have been irrelevant during much of the last three years, as the charging bull market never stopped to catch its breath. There were simply no capital losses to harvest.

Well, it may be time to dust off the paper. September has been a difficult month for stocks, especially in Canada, and investors with large portfolios might now have their first tax-loss selling opportunity since 2011.

No gain, no pain

Let’s start with a refresher on how tax-loss selling works. In a non-registered account, when you a sell a security that has declined in value, you realize a capital loss. You can use these to offset any capital gains you’ve incurred in the current year, which can reduce your tax bill. Moreover,

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Foreign Withholding Taxes in International Equity ETFs

It seems Canadian ETF providers are paying more attention to foreign withholding taxes these days. Not so long ago, you rarely heard anyone discussing this hidden drag on returns. But last month BlackRock announced a significant change to its iShares Core MSCI EAFE IMI Index ETF, ticker symbol XEF, which makes up the international equity component of my Global Couch Potato portfolio. The change was made specifically to reduce the impact of foreign withholding taxes.

When the fund was launched in April 2013 it simply held a US-listed ETF, the iShares Core MSCI EAFE (IEFA). That was a convenient way of getting exposure to the 2,500 or so stocks in this large index. Over the last three weeks, however, XEF has gradually bought up the individual stocks in the index and now holds them directly. According to BlackRock:

“XEF will generally no longer be subject to U.S. withholding taxes. While foreign withholding taxes will continue to apply to dividends paid on certain international equity securities included in the XEF Index, it is expected that the change in investment strategy implementation will reduce the overall amount of withholding taxes borne directly or indirectly by XEF.”

A refresher course on foreign withholding taxes

A few words of explanation will help here.

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Ask the Spud: Should I Use Global Bonds?

Q: I was surprised to see a Vanguard infographic pointing out that international [non-US] bonds are the largest asset class in the world. Do you have any thoughts on why Canadians have not embraced international bonds in their portfolios? – A.M.

While stocks grab all the headlines and dominate the conversation among investors, the bond market is vastly larger. Yet while a diversified index portfolio can include 10,000 stocks from over 40 countries, chances are your bond holdings are entirely Canadian.

There are some good reasons for a strong home bias in bonds. The main one is currency risk. Exposure to foreign currencies benefits an equity portfolio by lowering volatility (at least for Canadian investors), but taking currency risk on the bond side is usually unwise. Because currencies are generally more volatile than bond prices, you’d be increasing your risk without raising your expected return. That’s a bad combination.

It also gets to the heart of why few Canadians have international bonds in their portfolios: there just aren’t many good products offering global bond exposure without currency risk. iShares and BMO have a number of ETFs covering US corporate and emerging markets bonds.

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Managing Multiple Family Accounts

Model portfolios like those I recommend are ideal for investors who have a single RRSP account. But life isn’t so simple once you’ve accumulated a significant portfolio: chances are you’ll be managing two or three accounts, and if you have a spouse there may well be a few more.

In most cases, it’s most efficient to consider both partners’ retirement accounts as a single large portfolio. In other words, there’s no my money and my spouse’s money: there’s only our money. This strategy has a couple of advantages: first, it allows the family to make the most tax-efficient asset location decisions. Second, it keeps the overall number of holdings to a minimum, which reduces transaction costs and complexity.

Meet Henry and Anne, who have a combined portfolio of $480,000. Let’s assume they are the same age and plan to retire at about the same time. Their financial plan revealed that a mix of 50% bonds and 50% stocks is suitable for their risk tolerance and goals. Anne has a generous defined benefit pension plan and therefore has little RRSP room: most of her personal savings go to a non-registered account.

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An Inside Look at the Financial Media

Investors love to rip into the financial media, and with good reason. So much of what passes for “investor education” is little more than worthless forecasts and attempts to explain random noise (“Canadian markets down on disappointing Portuguese GDP report”). More insidious are the pundits who do little more than talk their own book.

There’s a lot of this familiar criticism in Clash of the Financial Pundits, but what makes this new book so compelling is that the harshest words come from media commentators themselves. Authors Jeff Macke (formerly of CNBC’s Fast Money) and Joshua Brown (a CNBC contributor who blogs at The Reformed Broker) have set out to help readers and viewers be smart consumers of financial media. What should you heed and what should you ignore? The highlights are the detailed interviews with TV pundits, serious journalists, celebrity money managers and the inimitable Jim Cramer.

One of the recurring themes in the book is the relentless pressure on the financial media to produce entertainment, even if it means giving investors terrible advice. The easiest way to ensure you’ll never be invited back on CNBC is to admit you don’t know where the market is headed,

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