Archive | Indexes

The Wait is Over: New ETFs From Vanguard

“Ask and ye shall receive.” That should be the refrain of Couch Potato investors during the last 10 months or so as the industry has filled just about all the gaps in the ETF marketplace.

First it was the flurry of S&P 500 ETFs without currency hedging: Vanguard, BMO, iShares and Horizons have all launched one since October. Then iShares brought out a pair of broadly diversified international equity ETFs, also without the hedging. Now Vanguard Canada has announced a new suite of ETFs that includes a few we’ve been eagerly awaiting.

Vanguard filed the preliminary prospectus for these new ETFs on June 19, and since new products typically appear about 90 days later, at least some should start trading by the end of summer.

First there’s the long-awaited Vanguard U.S. Total Market, an unhedged version of VUS. Its underlying holding will be the US-listed version of this fund, the Vanguard Total Stock Market (VTI), a core piece of my Complete Couch Potato.

While the fees for the new ETFs haven’t been announced,

Continue Reading 49

Is One Index Really Better Than Another?

Couch Potato investors try to capture the returns of entire asset classes rather selecting individual securities. And we do that with passively managed funds designed to track indexes that represent each of those asset classes. But which index, exactly?

Since Vanguard announced last fall that it would be ending its relationship with the index provider MSCI, the question is worth considering. Vanguard’s Canadian equity ETF, for example, was originally benchmarked to the MSCI Canada Index but now tracks the FTSE Canada Index. Can investors expect the fund to behave differently now?

The short answer is yes, but the full story is more subtle: if the past decade is any guide, the performance of the two indexes will vary from year to year. But the differences are likely to be the result of random noise, and neither of these benchmarks can be said to have any meaningful advantage over the other.

There’s more than one way to measure the market

Investors often refer to “the index” the same way they refer to “the dictionary.” But in both cases, the definite article isn’t really appropriate: there isn’t a single authority.

Continue Reading 9

Two Core ETFs Get New Indexes

Vanguard announced last October that it would be ending its relationship with MSCI, one of the largest index providers in the world, and using new benchmarks for many of its most popular ETFs. That transition is now complete. Between January and April of this year, Vanguard Canada’s emerging markets equity, Canadian equity, and international equity ETFs all got new indexes created by FTSE. And earlier this month Vanguard changed the benchmark for two US-listed ETFs that happen to be core holdings in my Complete Couch Potato portfolio.

The Vanguard Total Stock Market (VTI) is now benchmarked to the CRSP US Total Market Index rather than the MSCI US Broad Market Index. The Canadian-listed version of this fund, the Vanguard US Total Market Index (VUS), simply holds VTI and adds currency hedging, so it is affected by the index change as well.

Don’t expect any meaningful effect on the performance of VTI. The CRSP index is slightly broader than its MSCI counterpart: the latter “targets for inclusion 99.5% of the capitalization of the US equity market,” while the former “represents approximately 100% of the investable US stock market.” That means the CRSP index will include more micro-cap stocks,

Continue Reading 8

Why Use a Strip Bond ETF?

Barry Gordon admits he was surprised when he first read Justin Bender’s entry in First Asset’s Search for Canada’s Next Top ETF contest, which I introduced in my previous post. “It runs against the grain of everything we thought we knew about strip bonds,” he says. But Gordon’s firm turned the idea into the First Asset DEX 1-5 Year Laddered Government Strip Bond Index ETF (BXF), which begins trading next Tuesday. Here’s an overview of this innovative new index fund, as well as an explanation of how it might be used in a portfolio.

Inside the ETF

First Asset tasked PC-Bond with creating the index for their new strip bond ETF. Here’s the basic methodology:

the ladder will have “term buckets” with bonds of approximately one, two, three, four and five years to maturity
each bucket will include five individual strip bonds: four provincial (mostly issued by Ontario and Quebec) and one federal (or federal agency)
the bonds will be selected with liquidity in mind: the issues must be at least $50 million and will be screened for maximum trading volume
the index will rebalance annually in June: bonds with less than one year to maturity will be sold and the proceeds used to purchase new bonds for the five-year bucket

No surprises so far.

Continue Reading 28

More on Socially Responsible Index Investing

Here’s part two of my conversation with Timothy Nash, president of Strategic Sustainable Investments and the blogger behind The Sustainable Economist. (Part one is available here.) Next week I’ll go into more detail about specific investment products that combine passive investing with SRI principles.

Many socially responsible investors seem to think buying a company’s stock is somehow giving them capital they can use to do evil, and that’s why they’re wary about owning index funds. I’m not sure I buy that argument.

TN: I often get asked how much of a difference I’m making by owning socially responsible index funds or ETFs. And it’s tricky, because obviously when you own equities the money doesn’t go directly to the company—at least not once you’re beyond the IPO. But you can make the argument about cost of capital. When companies have a large market cap, the more demand there is for that stock, and the easier it is for them to raise capital.

There is another argument, too. With ethical consumerism—whether you’re buying fair trade, or local, or organic—you are impacting that invisible hand of the marketplace.

Continue Reading 15

When You Can Ignore Tracking Error

In Monday’s post, I reviewed the major factors that contribute to an index fund’s tracking error. Here are some other things to consider when you’re comparing your fund’s performance to that of its benchmark. These can cause tracking errors to seem unusually large or small, but they need to be understood in context.

Changes to the index. A number of ETFs changed their benchmark index during 2012, including some core equity funds from BMO and Vanguard. When there is an index change in the middle of the year, measuring tracking error becomes difficult and the numbers can be misleading. Until late September, the BMO S&P 500 Hedged to CAD (ZUE) held just 100 large-cap stocks selected using a different methodology. ZUE ended up lagging the S&P 500 by less than its management fee, which is normally an excellent result, but in this case it was a fluke.

A small number of ETFs in Canada are not tied to any third-party benchmark. The BMO Canadian Dividend (ZDV), for example, includes 30 stocks selected using an in-house methodology. In cases like this,

Continue Reading 3

What Causes an ETF’s Tracking Error?

Last week I explained the importance of monitoring an ETF’s tracking error, which is the difference between a fund’s actual performance and the returns of its index.

The most significant reason index funds lag their benchmarks is the impact of management fees and GST/HST. If your index fund has an MER of 0.25%, you should expect its tracking error to be within a basis point or two of that figure. But it’s often more than that—and sometimes it’s much less. In a series of two posts this week, I’ll look at some real examples from 2012 to illustrate the other factors that can cause an ETF’s returns to vary.

Currency hedging. US and international equity ETFs hedge currency risk using futures contracts. These are renewed every month, and if there’s a dramatic currency movement between contracts—or if the fund experiences a large cash inflow or outflow—that can show up as tracking error. The iShares S&P 500 (XSP) and Vanguard MSCI U.S. Broad Market (VUS) both had tracking errors over 70 basis points in 2012, despite MERs of just 0.24% and 0.17%, respectively.

Currency hedging can also work in the fund’s favour,

Continue Reading 8

How Well Does Your ETF Track Its Index?

The ideal index fund would deliver the precise return of its benchmark, but we all know that’s not realistic. ETFs and index funds may be cheap but they’re not free, and fees almost always cause them to lag slightly. Index investors accept this because they know the alternatives are usually much worse, but they can’t be too complacent. It’s important to periodically check your ETF’s tracking error: that is, the difference between the index return and the fund’s actual performance.

Where do you find this information? Over at iShares, you simply visit the ETF’s web page and click the “Performance” tab. You’ll see the returns of both the fund and its index over various periods from one month to 10 years, as well as calendar-year returns. iShares currently lists fund returns according to net asset value (NAV) only: the market price field is blank. For example, over the 12 months ending March 31 the iShares S&P/TSX Capped Composite (XIC) lagged its index by 29 basis points:

The process is almost identical at Vanguard: again, simply visit the ETF’s web page and click the “Performance” tab.

Continue Reading 16

New iShares ETFs Give Canadians the World

In an era when ETFs are becoming increasingly narrow and specialized, the new iShares funds launched this week were a pleasant surprise.

Granted, they were late to the game with the iShares S&P 500 (XUS), which is now the fourth ETF that tracks the S&P 500 with no currency hedging. (Vanguard, BMO and Horizons all beat them to market.) But the two international equity ETFs are a lot more interesting. In fact, the iShares MSCI EAFE IMI (XEF) and the iShares MSCI Emerging Markets IMI (XEC) are the most significant index funds to be launched in Canada in at least six months.

We are the 99%

The “IMI” in the name of the international funds stands for Investable Market Index. These MSCI benchmarks are designed to capture 99% of the equity market in a given region, including large, mid, and small cap companies. This is the same strategy used by the Vanguard Total International Stock (VXUS), a core holding in my Complete Couch Potato portfolio.

All three of the new funds simply hold an existing US-listed ETF in the iShares Core Series,

Continue Reading 98