Archive | ETFs

Model Portfolio Update for 2017

After two years with no changes to my Couch Potato model portfolios, the 2017 version comes with an update to the ETF version.

Before I get to the details, I feel compelled to stress that if you’re currently using the older ETF portfolio, there is absolutely no reason to change. The funds I’ve swapped here are a wee bit cheaper, but the cost of selling your existing ETFs and buying the new ones almost certainly outweighs the benefits. And if the transactions would involve realizing taxable gains, then making a switch is downright nutty. To put this in perspective, the new portfolios will reduce your management fees by 0.03% annually, which works out to 25 cents a month on every $10,000 invested.

I’ve also updated my  model portfolios page with historical returns to the end of 2016. As always, we’ve used actual fund performance wherever possible: for earlier periods we’ve used index data, subtracting the fund’s current MER to account for costs.

With that out of the way, here are the changes.

Zigging over to ZAG

First, I’ve replaced the Vanguard Canadian Aggregate Bond Index ETF (VAB) with the BMO Aggregate Bond Index ETF (ZAG).

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Making Sense of Capital Gains Distributions

Imagine you’re part of a group of 10 friends at a restaurant to celebrate the holidays. Everyone else arrives on time and enjoys cocktails, appetizers and a main course, while you get stuck in traffic and barely make it in time for dessert. At the end of the meal, the server brings 10 separate bills, each for the same amount. “But I only had a slice of pie!” you complain. “Why am I paying for a full meal?”

If you’re an ETF or mutual fund investor who makes a large purchase in December, you may end up feeling the same way. That’s because some funds distribute capital gains at the end of the year, and you’re on the hook for the taxes whether you’ve held the fund for a couple of weeks or the full 12 months. (Note this only applies to non-registered accounts: you don’t need to worry if you’re using only RRSPs and TFSAs.)

Giving them the slip

Let’s back up and review why this happens. Mutual funds and ETFs occasionally sell investments that have increased in value, resulting in capital gains. Over the course of the year, a fund may also do some tax-loss harvesting to realize losses that can offset some or all of those gains.

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Ask the Spud: Reverse Share Splits in ETFs

Q: I noticed the unit price of some iShares ETFs changed radically last week. For example, the iShares MSCI Singapore ETF (EWS) shot up from around $10 to $20 overnight on November 7. Another fund went from $14 to over $28. What’s going on here, and how would it affect investors? — Chris

If you wake up to find the unit price of your ETF doubled overnight, you might be tempted to think you just scored a 100% return while you slept. But unless you’re an eternal optimist, you’ll probably realize that isn’t the case. What’s happened here is called a reverse share split, or consolidation. Although the price per share of these iShares ETFs doubled (or in some cases quadrupled), the total value of each investor’s holding hasn’t changed, because they now own correspondingly fewer units.

If you’ve ever traded stocks, you’re probably more familiar with a regular stock split, whereby a company increases its number of outstanding shares by some multiple, reducing the price of each share by a proportional amount. A company with one billion shares trading at $100 might undergo a 4-for-1 split, creating four billion shares trading at $25.

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Foreign Withholding Taxes Revisited

Justin Bender and I have just completed the second edition of our popular white paper, Foreign Withholding Taxes: How to estimate the hidden tax drag on US and international equity ETFs.

Originally published in 2014, the paper explains how many countries impose a tax on dividends paid to foreign investors—most notably a 15% levy on US stocks held by Canadians. When the first edition appeared, foreign withholding taxes were not well understood by many investors and advisors, and even the ETF providers rarely discussed them. In the two years since, the issue seems to be getting more recognition. Both Vanguard and iShares, for example, have made changes to their international equity ETFs to make them more tax-efficient. That’s great news, though it also made the first version of our paper somewhat dated.

In this new edition, we’ve made some significant changes. First, we’ve removed corporate accounts from the discussion and focused on personal accounts only. We’ve also used some different ETFs in our examples, including the Vanguard U.S. Total Market (VUN), the Vanguard FTSE Developed All Cap ex U.S. (VDU) and the iShares Core MSCI EAFE IMI (XEF).

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Cost Versus Convenience in “ex Canada” ETFs

I used to own one of those one-piece cutlery tools designed for hiking and camping—the kind with a knife, fork and spoon that all fold into a single unit. It was hardly ideal for eating, especially if you needed the fork and knife at the same time. But it was more convenient than trekking around with three individual pieces of flatware that might tear your pack or get left behind on the trail.

As investors we often make similar trade-offs. Consider the Vanguard FTSE Global All Cap ex Canada (VXC) or the iShares Core MSCI All Country World ex Canada (XAW), which both offer one-stop global diversification by holding thousands of US, international and emerging market stocks. But as with folding cutlery, you give up something to get that convenience. These two “ex Canada” funds get at least some of their exposure by holding underlying US-listed ETFs rather than holding their stocks directly. This structure can result in additional foreign withholding taxes on dividends.

In a recent blog post, Justin Bender estimated the impact of foreign withholding taxes on RRSP investors who hold VXC.

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The Curious Case of the BMO Discount Bond ETF

When the BMO Discount Bond Index ETF (ZDB) was launched back in February 2014, it was unique: the first broad-market ETF in Canada made up primarily of bonds trading below their par value. By avoiding premium bonds, ZDB promised to deliver similar returns to traditional bond funds, but with greater tax efficiency, making it ideal for non-registered accounts. With a little more than two years of real-word performance, it’s time for a checkup. Has ZDB delivered on its promises?

Top of the heap

The first question we’ll examine is whether ZDB achieved pre-tax returns similar to other broad-market bond ETFs. The fund was designed to match the popular FTSE TMX Canada Universe Bond Index in credit quality, average term, duration and yield to maturity. But ZDB set out to achieve this profile using bonds with lower coupons to reduce the amount of taxable income.

As it turns out, ZDB outperformed all of its competitors in 2015. Here are the NAV returns for the calendar year:

BMO Discount Bond
ZDB
3.60%

Vanguard Canadian Aggregate Bond
VAB
3.48%

iShares Core High Quality Canadian Bond
XQB
3.38%

BMO Aggregate Bond
ZAG
3.24%

iShares Canadian Universe Bond
XBB
3.15%

Sources:  BMO ETFs,

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How Long Will You Wait for Smart Beta to Work?

In my last post I shared some insights from Ben Carlson’s A Wealth of Common Sense, which argues that investors are generally better off keeping their portfolios simple and straightforward. This idea has little appeal for index investors who hope to improve on plain-vanilla funds by using so-called smart beta strategies.

“Smart beta” refers to any rules-based strategy that attempts to outperform traditional cap-weighted index funds. Now more than a decade old, fundamental indexing is the granddaddy of smart beta, while factor-based strategies are the newer kids on the block. In each case, the goal is to build a diversified fund that gives more weight to stocks with certain characteristics (value, small-cap, momentum, and so on) that have delivered higher returns than the broad market over the long term.

Many proponents of passive investing see huge potential in factor-based strategies because they combine the best features of indexing—low-cost, broad diversification, and a rules-based process—with the potential to overcome the shortcomings of traditional cap-weighting. Indeed, many of our clients at PWL Capital use a combination of traditional ETFs and equity funds from Dimensional Fund Advisors (DFA),

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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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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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