Archive | ETFs

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,

Continue Reading 23

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),

Continue Reading 26

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.

Continue Reading 93

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,

Continue Reading 25

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.

Continue Reading 31

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,

Continue Reading 20

Vanguard’s VXC Gets a Facelift

The Vanguard FTSE All-World ex Canada (VXC) allows Canadians to get access to US, international and emerging markets equities with a single ETF, and it’s one of the ingredients in my model portfolios. Vanguard recently announced some planned changes to VXC’s benchmark index, so let’s take a closer look.

Right now, VXC holds only large and mid-cap stocks, but it will soon be adding small-caps to the mix—at least for overseas markets. This will come about indirectly as a result of changes to the benchmark indexes of three of the fund’s underlying holdings.

VXC gets exposure to international developed and emerging markets through three US-listed ETFs: Vanguard FTSE Europe (VGK), Vanguard FTSE Pacific (VPL) and Vanguard FTSE Emerging Markets (VWO). These will soon begin tracking new “all cap” indexes that include small companies as well as large and mid-caps. Vanguard estimates that small-caps will eventually make up about 10% of each ETF. To reflect these changes, VXC will receive a new name: the Vanguard FTSE Global All Cap ex Canada Index ETF.

But it’s not clear whether VXC will add small-caps to its US equity exposure.

Continue Reading 22

Are Preferred Share Indexers Dumb Money?

It’s hard to keep a straight face while arguing for active strategies in asset classes like large-cap stocks or government bonds. Those markets are so liquid and so well covered by analysts that it’s almost impossible to find and exploit inefficiencies. But many would argue that active managers at least have a fighting chance in asset classes that like, say, emerging markets or small-cap stocks.

On the heels of my previous posts on Canadian preferred shares, let’s consider whether this is another asset class where active managers can be expected to add value compared with a simple indexed approach using ETFs. I recently explored this idea in a conversation with Nicolas Normandeau of Fiera Capital, who manages the Horizons Active Preferred Share ETF (HPR). I think it’s important to have these debates occasionally, because if you believe in indexing, it’s important to be able to defend the strategy with rational arguments and not ideology.

Here are the main arguments in favour of using an active strategy with preferred shares:

The market is complex and inefficient. The entire preferred share market in Canada is about $60 to $65 billion—about the same as the market cap of Canadian National Railway.

Continue Reading 15

When Discount Bonds Are Hard to Find

Everyone loves a discount, but if you’re buying bonds these days you may be out of luck.

Just over a year ago, the BMO Discount Bond (ZDB) was launched as a tax-efficient alternative to traditional bond ETFs. ZDB tracks the broad Canadian market, but it selects bonds trading at a discount, or at a very small premium. Discount bonds have a lower coupon than comparable new bonds, and they will mature with a small capital gain. That combination is more tax-efficient than premium bonds, which have higher coupons and mature at a loss.

A discount bond ETF is a great idea for non-registered accounts, but it faced challenges from the beginning. After many years of interest rates trending downward, there simply aren’t many discount bonds in the marketplace. Traditional broad-market bond ETFs hold between 500 and 900 issues, but ZDB holds just 55.

This constraint has become more urgent after the Bank of Canada unexpectedly cut short-term rates in January. Yields on intermediate and longer-term bonds also fell, driving bond prices up sharply. Suddenly bonds that were trading at a discount were priced at or above par.

In my blog post introducing ZDB,

Continue Reading 23