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Are Target Date Funds Right For You?

Think about all the elements you need to be a successful index investor. First, you need to choose the right mix of stocks and bonds, and to adjust that mix as you approach retirement. Your portfolio needs to be broadly diversified and low-cost. You need to save part of your paycheque in a disciplined way, rebalancing your portfolio from time to time, and resist distractions so you won’t be tempted to abandon your plan.

If you have a defined contribution pension plan or group RRSP through your employer, there may be a simple solution: the target date fund. These products were created in the 1990s for workplace investment plans in the US, and they’re now widespread in Canada, with BlackRock’s LifePath and Fidelity’s ClearPath family the most common. These incumbents will now face a challenge from Vanguard, who manages over $358 billion USD in target date funds in the US and recently announced its own series of Target Retirement Funds in Canada.

The idea behind target date funds is brilliantly simple: each one is balanced portfolio of bonds and global equities in various proportions,

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The Next Smart Beta Revolution

{Note: This post was an April Fool’s joke!]

As the ETF industry in Canada matures, more and more providers are moving away from traditional cap-weighted index funds in favour of more exotic strategies, which have been lumped together under the label smart beta. The goal is to build indexes that will deliver excess returns by adding more exposure to stocks with specific characteristics, known as factors.

For example, small cap stocks in the U.S. beat the S&P 500 by almost 2% a year from 1926 through 2012  (the size factor), while stocks with a low price-to-book ratio outperformed by a similar amount (the value factor). More recent evidence has revealed other factors, such as momentum and profitability. Now a group of academics has discovered a way to combine all of these factors into a single strategy that will revolutionize the way we invest.

The researchers have not yet published their findings, but I recently had a chance to interview the group’s leader, Dr. Molti Fattore, professor of financial engineering at the University of Milan. “It’s really very simple,” he explains. “We’ve known for a long time that the various factors can boost returns by a percentage point or two compared with the broad markets.

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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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Announcing the Couch Potato Robo-Advisor Service

[Note: This was an April Fool’s joke!]

One of the most exciting developments in investing is the rise of online wealth managers, also known as robo-advisors. These services offer online portfolio management at a fraction of the cost of a full-service advisor. We’ve seen a number of these services pop up in Canada in the last year so, and I am happy to announce that my colleagues at PWL Capital are set to launch our own online service for Couch Potato investors. Best of all, it will be absolutely free.

We’ve nicknamed our service Bender, in honor of the lovable robot character from TV’s Futurama. (Any resemblance to the name of a human portfolio manager is purely coincidental.) Bender will be unlike any other robo-advisor, because it won’t actually make any trades in your account: it will simply give you voice instructions. Then you’re responsible for carrying them out.

This is something of a revolution in the robo-advisor space. Provincial securities regulators have put up high barriers for online wealth managers: they simply don’t like the idea of robots making bad investment decisions when human advisors are perfectly capable of doing that on their own.

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iShares Expands Its Core ETF Lineup

iShares shook up the ETF marketplace last March when it launched its Core family of low-cost ETFs in the major asset classes. This week iShares announced some new additions to its Core lineup, including two broad-market funds that go head-to-head with recently launched ETFs from Vanguard. Let’s take a peek at these compelling new offerings.

Blanket coverage of the US

First up is the iShares Core S&P U.S. Total Market (XUU), which provides exposure to the broad US stock market, including large, mid and small cap stocks.

This is iShares’ answer to the Vanguard U.S. Total Market (VUN), and it comes in five basis points cheaper, with a management fee of just 0.10%. However, the coverage is not quite as complete: VUN holds more than 3,800 stocks, compared with 1,500 for XUU. Although XUU’s benchmark is the S&P Total Market Index (which includes almost 3,900 companies) the fund actually holds three US-listed ETFs that make up the S&P Composite 1500 Index. But we should keep this in perspective: the other 2,300 companies are so small that they collectively make up just 10% of the US market,

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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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