Archive | 2015

Decoding Vanguard’s New International Equity ETFs

This year has been another reminder of why international equities are such an important part of a diversified portfolio: in the first 11 months of 2015 the Canadian market was down almost 6%, while international developed markets were up close to 15%.

On December 9, Vanguard Canada launched two new ETFs tracking international equities: the Vanguard FTSE Developed All Cap ex North America (VIU) and a currency-hedged counterpart that uses the ticker VI. These new funds are a welcome addition to Vanguard’s ETF lineup, but they make the choices more confusing, because there are already similar funds on their menu. So let’s try to sort it all out.

First, the background. Vanguard Canada seems to have been put in an awkward position by recent changes to their benchmark indexes. Back in June, their US parent company announced that four international equity indexes provided by FTSE would expand to include mid-cap and small-cap stocks as well as China A-shares. Those were potentially useful changes that added more diversification. However, they also announced that the FTSE Developed ex North America Index would eventually become the FTSE Developed All Cap ex US Index.

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The Trouble With Bashing Bond Indexes

In my last post, I looked at a tired criticism of traditional equity index funds. Similar arguments have been made against fixed-income index funds, most recently in a blog post called The Trouble With Bond Indices produced by Mawer Investment Management. And once again, they don’t hold up to scrutiny.

First the background. Bond indexes, like their equity counterparts, are usually weighted by market capitalization. This means governments and companies that issue the most bonds (by dollar value) receive the largest weight in the index. Most index investors in Canada use funds that include only domestic bonds, and typically these are roughly one-third federal government bonds, one-third provincial and municipal bonds, and one-third corporate bonds. Global bond index funds are much less common in Canada (only Vanguard offers an ETF in this asset class), but the principle is the same: countries that issue the most debt receive the greatest weight in the index.

You may have already spotted the potential red flag: the more debt a country or company has on its books, the more of its bonds you’re likely to own if you use an index fund.

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Are Index Funds Fatally Flawed?

“No one pretends that democracy is perfect or all-wise,” Winston Churchill famously said in a 1947 speech. “Indeed, it has been said that democracy is the worst form of government except all those other forms that have been tried.”

I recalled this bit of wisdom recently when two readers sent me links to articles that question the safety of index funds. Both identify genuine flaws in traditional cap-weighted index funds. But the problem—as always—is that the alternatives turn out to be worse. In this post, I’ll look at some of the arguments levelled at equity index funds. Next time, we’ll turn the focus to bond indexes.

Earlier this month, the venerable New York Times ran an article called The Ease of Index Funds Comes With Risk. The piece acknowledges the many benefits of index ETFs but then warns that “their simplicity harbors some simmering problems, which have grown more troubling in the course of the bull market in stocks.” It goes to say that “cracks in the edifice of passive investing are beginning to show.”

Experts in the article are concerned that the mere inclusion of a stock in a major index—particularly the S&P 500 of large-cap stocks and the Russell 2000,

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Vanguard’s New World Order

If you follow my model ETF portfolios, you may have noticed that one of your holdings has a new name.

The Vanguard FTSE All-World ex Canada (VXC), launched in the summer of 2014, is a simple, low-cost way to get exposure to stocks in the US as well developed and emerging markets overseas. Now VXC has evolved to cover even more of the global equity market, and further expansion is planned for the coming months. To reflect these changes, the fund recently changed its name to the Vanguard FTSE Global All Cap ex Canada Index ETF. The ticker symbol remains unchanged.

VXC is an “ETF of ETFs” with four underlying holdings: the Vanguard Large-Cap (VV), the Vanguard FTSE Europe (VGK), the Vanguard FTSE Pacific (VPL), and the Vanguard FTSE Emerging Markets (VWO). The latter three ETFs recently adopted new benchmark indexes that include small-cap stocks as well as large- and mid-caps. As a result, the total number of stocks held by VXC has swelled from just over 3,000 at the end of August to more than 5,100 today.

The addition of all those stocks makes VXC more diversified than ever,

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The ETF Volume You Can’t Hear

Most investors prefer using ETFs that are bought and sold frequently. Although thinly traded ETFs are not always less liquid, experienced investors will tell you that they do tend to have wider bid-ask spreads. A healthy trading volume also suggests there’s a lot of interest in the ETF, which makes it less likely to be shut down.

You can get an idea of an ETF’s trading volume by looking at a quote from your discount brokerage or from free online services such as Google Finance. But you’re probably not getting the whole story: you may be surprised to learn that your ETFs are trading more often than you’ve been led to believe.

Here’s why: when you get a quote from these sources, chances are the data is coming only from the Toronto Stock Exchange. But although the TSX gets all the attention, it’s not the only ETF marketplace in Canada: there are several so-called alternative trading systems (ATS) that match buyers and sellers behind the scenes. These include Alpha, Chi-X, Omega, and many others—even some that aren’t named for a letter in the Greek alphabet.

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Is a Pullback Really a Buying Opportunity?

The Canadian, US and international markets all fell more than 5% last week, the sharpest weekly drop we’ve seen in almost four years. Then on August 24, global markets plunged even further. If you were waiting for a pullback to give you a buying opportunity, you just got it. But if you’re sitting in cash and paralyzed with fear, you’ve just learned how you can get into trouble when you invest without a plan.

Let me be clear before we go further: I’m not recommending that investors hoard cash and wait for big drops like this one. Let’s remember that the last time we saw a sharper one-week decline was September 2011. The opportunity cost of being uninvested—even for a couple of months, let alone four years—can be enormous. So if your savings are coming from a regular paycheque, you are better off setting up an automatic investment plan that removes the emotion from your decision making.

However, If you recently came into a large lump sum—from an inheritance, the sale of a property or business, or a pension payout—things are a little different. You are still likely to be better off investing the lump sum immediately rather than spreading it out over a year or two: studies have consistently shown that the all-in move delivers better results about two-thirds of the time.

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It’s Better With Beta

The title of Larry Swedroe’s latest book, The Incredible Shrinking Alpha, raises a question: what happened to the idea that skilled managers can consistently beat the market? In a recent interview with Swedroe, we discussed the idea that this ability hasn’t really disappeared: it’s just that “alpha has become beta.”

What exactly does that mean? In investing jargon, alpha is the name given to the excess return a fund manager achieves through skill. Beta, on the other hand, refers to the returns available to anyone who is willing to accept a known risk. When Swedroe says “alpha has become beta,” he simply means that anyone who understands how to structure a portfolio can increase their expected returns by simply changing their exposure to specific types of risk, known as “factors.”

A factor is a characteristic of a stock that affects its expected return and risk. Factor investing (sometimes marketed as “smart beta”) means identifying which of these characteristics might predict higher returns in the future—even if it also brings more risk—and then building a diversified portfolio that captures those returns in a systematic way,

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Is Beating the Market Harder Than Ever?

Is beating the market harder than it’s ever been? Larry Swedroe thinks so, and he lays out his case in his newest book, The Incredible Shrinking Alpha.

PWL Capital has just published a custom edition of the book, with a foreword I co-wrote with my colleague Ben Felix. In our introduction, Ben and I note that Swedroe likes to use sports analogies when he discusses investing. I recently chatted with Swedroe about the book, and he looked to baseball and tennis to explain why active investors face more difficult obstacles than ever.

Outliers in the outfield

Swedroe begins with an argument that others have invoked before: the disappearance of the .400 hitter in baseball. Since 1903, seven different players have batted .400 or better a total of 12 times. However, that feat has not been accomplished since 1941, when Ted Williams hit .406 for the Boston Red Sox. “Of course, the skill of the pitchers today is much higher, and the fielders are much better,” he notes, so that might explain why batting .400 is considered almost impossible today. However, over the last 50 years,

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Ask the Spud: My ETF Is Shutting Down

Q: I received a notice that an ETF I own will be closed within the next few months. Is it better to sell it now or wait until the termination date? – S.H.

ETFs are now available for just about every niche sector and exotic asset class, so it shouldn’t be surprising when some of these fail to attract investor dollars. If an ETF cannot attract enough assets to be sustainable within a couple of years, the provider may decide to shut down the fund.

ETF closures have been relatively uncommon in Canada, but this year has seen several death sentences. In June, BlackRock announced it will be shuttering six products, including the iShares Broad Commodity (CBR), the iShares China All-Cap (CHI), iShares Oil Sands (CLO) and the iShares S&P/TSX Venture (XVX). Earlier in the year Horizons also terminated its broad commodity ETF as well as couple of its leveraged ETFs.

What should you do if you learn that an ETF you own will soon be shut down? To help answer this question, I reached out to Mark Noble, ‎head of sales strategy, communications and public relations at Horizons ETFs.

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