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Ask the Spud: Bond ETFs in Taxable Accounts

Q: Can you share your thoughts about the BMO Discount Bond (ZDB) and the Horizons Canadian Select Universe Bond (HBB) as long-term holdings in a taxable account? – D. F.

Earlier this year BMO and Horizons both launched bond ETFs specifically designed for taxable accounts. These two funds have very different structures, and each has its strengths and weaknesses. So let’s dig more deeply into each fund to help you decide which might be right for your portfolio.

Before we discuss these specific funds, let’s review the problem with holding traditional bond ETFs in non-registered accounts. Most bonds these days trade at a premium (higher than their par value), because they were issued when interest rates were higher. Premium bonds are perfectly fine in your RRSP or TFSA, but they are notoriously tax-inefficient and should not be held in non-registered accounts.

 Do you want a discount or a swap?

The BMO Discount Bond (ZDB), launched in February, is similar to traditional broad-market bond ETFs, such as the iShares Canadian Universe Bond (XBB), the Vanguard Canadian Aggregate Bond (VAB) and the BMO Aggregate Bond (ZAG).

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An Interview With Wealthsimple: Part 2

Earlier this week I published an excerpt from my interview with David Nugent, portfolio manager of the online investment service Wealthsimple. In this second part of our interview, Nugent goes into more detail about the firm’s investment strategies, including the individual funds they use in their portfolios.

Let’s say you’ve determined an investor’s appropriate asset mix is 60% equities and 40% fixed income. Can you describe how you would divide that across various asset classes?

DN: Our asset classes are Canadian equities, US equities, foreign developed market equities, emerging markets, dividend stocks and real estate, and then there is a component of tactical stocks. The fixed income piece is Canadian investment-grade corporate bonds, Canadian government bonds, US high-yield bonds and cash.

When it comes to choosing ETFs, we try to get the broadest exposure in each asset class. We’re looking to try to capture large caps, mid caps and small caps because we believe that over the long term there is value in having some exposure to that small cap space: they tend to outperform large caps over extended periods. So for Canadian, US, foreign developed and emerging market equities we use total-market cap-weighted ETFs.

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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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Drilling Down into the iShares Core ETFs

When iShares launched its Core ETF series back in March it made some waves in the industry. The company cut the fees on nine ETFs it considers building blocks of a long-term portfolio. Its boldest move was to slash the cost of one of its flagship products, the iShares S&P/TSX Capped Composite (XIC). At the time XIC was weighed down by a management fee of 0.25%, much higher than its competitors from Vanguard and BMO. After that fee was reduced to a stingy 0.05%—making it the cheapest ETF in the country—it prompted BMO to follow suit less than a month later.

Now more moves are afoot. On July 21, iShares rebranded these nine ETFs to include “Core” in their names. They also launched a new addition to the family: the iShares Core Short Term High Quality Canadian Bond (XSQ).

The new ETF is extremely similar to the iShares Canadian Short Term Bond (XSB) in most respects: both are about 60% government bonds and 40% corporates, and the holdings are all investment-grade (rated A or higher). Their fundamentals are almost identical:

XSB
XSQ

Yield to maturity
1.58%
1.55%

Average coupon
2.98%
2.81%

Duration
2.83
2.77

Average term
2.83
2.92

Source: BlackRock Canada

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Under the Hood: Vanguard FTSE All-World ex Canada (VXC)

This post is part of a series that takes a detailed look at specific Canadian ETFs or index funds.

The fund: Vanguard FTSE All-World ex Canada Index ETF (VXC)

The index: The fund tracks the FTSE All-World ex Canada Index, which includes “primarily large- and mid-capitalization stocks of companies located in developed and emerging markets, excluding Canada.” The index includes approximately 2,900 stocks in 46 countries.

The cost: The management fee is 0.25%. Since the fund is brand new we don’t know the full MER, but it should be less than 0.30% after adding taxes and incidentals.

The details: VXC started trading on July 7 and was one of five new Vanguard ETFs launched that day. The fund is a one-stop solution for those looking to diversify outside of Canada. Not so long ago, investors needed two or three ETFs to get exposure to the US, international developed markets and emerging countries (unless they were willing to buy US-listed ETFs). Now they can get it with a single fund.

VXC weights each country according to the size of its capital markets,

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ShareOwner: Canada’s First ETF Robo-Advisor

Back in February I wrote about the rise of robo-advisors, the online services that allow you to build an ETF portfolio that’s maintained by a computer. These services are already operating in the US, and several are in the works in Canada, including the start-ups Nest Wealth and Wealthsimple. But the first to market has turned out to be ShareOwner, a well-established firm better known to dividend stock investors.

I wrote about ShareOwner more than four years ago, and my review at the time was quite negative. They charged a $79 annual fee for RRSPs, their trading commissions were on the high side, and their menu of ETFs was mostly confined to niche products. But the firm has a new owner in Bruce Seago (a veteran of the online brokerage business) and a revamped offering. Their newly announced Model Portfolio Service has a lot of promise for ETF investors seeking a low-cost, low-maintenance solution.

Here’s an overview of how it works. When you open an account, you can select one of ShareOwner’s five model portfolios,

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Vanguard Goes Global With New ETFs

[Note: This blog post was updated several hours after it was published, as new information became available.]

The Vanguard Total International Stock ETF (VXUS) has long been part of my Complete Couch Potato portfolio, since it gives instant access to virtually all the world’s markets outside the United States. I’m frequently asked whether Vanguard is planning to launch a Canadian-listed version of VXUS, so investors could avoid the expense and hassle of converting their loonies to US dollars. The answer is probably no—but the solution might be even better.

Vanguard Canada announced today that it will launch five new ETFs later this year, the most interesting of which is the Vanguard FTSE All-World ex Canada. While full details have not been published yet, the preliminary prospectus explains the fund will track “the performance of a broad global equity index that focuses on developed and emerging markets, excluding Canada.” The management fee has been set at 0.25%.

This new ETF is not a Canadian wrapper for VXUS: it will include US stocks and exclude Canada, whereas VXUS does the opposite.

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A Tax-Friendly Bond ETF on the Horizon

Bonds should be part of just about every portfolio, but if you have to hold them in a non-registered account the tax consequences can be onerous. Fortunately, Canada’s ETF providers are taking steps to ease that burden with some innovative new products, including an ETF of strip bonds and another that holds only low-coupon discount bonds. The latest entry is the Horizons Canadian Select Universe Bond (HBB), which is set to begin trading this week. HBB is unique: it’s the only bond ETF in North America—and maybe anywhere—that uses a total return swap, which should dramatically improve its tax-efficiency.

The swap structure is the same one used by the Horizons S&P/TSX 60 (HXT) and the Horizons S&P 500 (HXS), which are now more than three years old. Here’s the basic idea: the ETF provider has an agreement with National Bank (called the counterparty) to “swap” the returns of two different portfolios. When you buy units in HBB, Horizons places your money in a cash account and pays the interest to the counterparty. In return, National Bank agrees to pay Horizons an amount equal to the total return of the fund’s index—that means any price change,

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Inside the RBC Quant Dividend Leaders ETFs

In January, RBC launched the Quant Dividend Leaders ETFs, a family of dividend-focused funds covering the Canadian, U.S. and international markets. I recently had a chance to speak with Bill Tilford, Head of Quantitative Investments at RBC Global Asset Management, to learn more about the new ETFs:

RBC Quant Canadian Dividend Leaders (RCD)
RBC Quant U.S. Dividend Leaders (RUD/RID.U)
RBC Quant EAFE Dividend Leaders (RID/RID.U)

The funds do not track a third-party index: rather, the portfolios are built using a rules-based methodology. Unlike the popular S&P Dividend Aristocrats indexes, which focus on past dividend growth, Tilford says the RBC ETFs try to be forward-looking. So in addition to screening for stocks with above-average dividend yield, the strategy also looks at three measures of financial strength to determine the sustainability of the dividends.

The first is called the Altman Z-score, which has been used since the 1960s to estimate the probability of a bankruptcy. “It also does a great job of forecasting dividend growth,” says Tilford. The other factors are the volatility of the firm’s return on equity (ROE) and the amount of short interest.

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