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Ask the Spud: Should I Unbundle My ETF?

2017-12-02T20:46:16+00:00October 10th, 2012|Categories: Ask the Spud, Asset Classes, ETFs|Tags: |17 Comments

Q: What do you think of investing directly in Canadian REITs instead of buying an ETF? It may be possible to achieve similar results without paying the ETF’s management fee. – Philippe V.

ETFs promise broad diversification at rock-bottom costs, but not necessarily in every asset class. Sector ETFs, in particular, still have relatively high fees in Canada. The BMO Equal Weight REITs (ZRE), for example, holds just 18 real estate investment trusts yet carries an MER of 0.62%, including the Ontario HST. The iShares S&P/TSX Capped REIT (XRE) charges about the same for an even smaller portfolio. (Vanguard has announced it will bring out its own REIT fund later this year with a management fee of just 0.35%.)

Since indexing is all about capturing an asset class’s returns at the lowest possible cost, does it make sense to simply buy all (or most) of the REITs in these funds directly and avoid management fees altogether? If your portfolio is very large, it might. But whenever you make a decision like this, you need to do the math carefully. Then you need to consider the convenience factor.

At the most basic level, ZRE’s management fee works out to $62 a year for every $10,000 invested. Establishing the initial position would involve just one trade, or an extra $10 at most brokerages. Buying each of the 18 REITs individually, by contrast, would incur no management fee, but would cost about $180 in commissions. As long as he or she made no subsequent trades, an investor with $10,000 would break even after about three years if they bought the REITs individually, while someone with $30,000 would come out ahead after less than one year.

Unfortunately, it’s not that simple. You also have to consider the following factors:

The number of trades in subsequent years. If you’re saving for retirement, chances are you’ll be adding money to your portfolio along the way. With a single ETF you can do so once or twice a year when you rebalance and incur minimal costs. With 18 REITs, you’ll be trading a lot more. You will still come out ahead if your REIT holdings are large, but it will take longer.

Bid-ask spreads. Investors who trade individual stocks sometimes think their only cost is the commission. In fact, the bid-ask spread usually results in a loss of much more than $10. ETFs also have bid-ask spreads, of course, but making a single ETF trade may result in a smaller loss than buying each of the fund’s holdings individually.

Tracking error. ZRE equally weights each REIT and rebalances semi-annually. If you’re buying each of the REITs individually, you’ll have to make at least 36 trades a year to track the index that closely. You may not be concerned about mirroring the index slavishly, and that’s reasonable enough, but you will need to rebalance your holdings occasionally.

Taxes. If you’re investing in a taxable account (which generally is not a good idea with REITs), holding the individual REITs will allow you more control over when you realize any capital gains. ZRE did distribute capital gains of just over four cents a share last year, which investors would have had to pay tax on even if they did not sell anything.

Convenience. Many investors are willing to pay a modest fee for the convenience of keeping their entire REIT allocation in a single fund. Not only does it reduce the frequency of your trades, it also makes it easier to rebalance your portfolio. Reinvesting monthly distributions is also more efficient with an ETF. In the end, you’ll need to decide what you’re willing to pay for low maintenance. Certainly as one’s REIT holdings gets larger (say, $50,000 or so) and the holding period gets longer, unbundling the ETF becomes compelling. For smaller amounts and shorter horizons, it’s not likely to be worth the effort.

For more about unbundling ETFs, see Norm Rothery’s article on the subject and check out his calculator to run the numbers. Both are now out of date, but Norm’s overall insights remain helpful.


  1. Jon Evan October 10, 2012 at 10:53 am

    The difficulty that I’ve experienced with unbundling and having a large number of stocks in my portfolio is that it is easy to fall in love with some stocks which is a problem believe me! This makes it more difficult when it comes to rebalancing which of course is vital to successful investing. It is harder then to sell a favorite stock and the urge to even buy more is harder to resist. Maintaining one’s asset allocation and rebalancing and being objective is far easier in a simple ETF portfolio making it relaxing and quick to manage particularly when you amass a large portfolio and are moving from accumulation phase into retirement. After all, you want to spend far more time on the couch rather than infront of a computer screen scratching your head :)!

  2. Mark October 10, 2012 at 10:55 am

    I long ago decided it was not worth investing in a Canadian REIT ETF and unbundled right from the start. Several issues for me. Firstly, I have $160,000 in REITS and that just a small percentage of my portfolio. I hold 11 positions so in establishing those positions I paid $6.95 per trade with CIBC as a large investor. This is far less than the annual MER I would paying through an ETF.

    Second issue you don’t really touch on. Which approach is the correct one: the weighted XRE ETF of Ishares or the equal wight ZRE? I don’t know so what should I do when trying to track “the index”. In the end, I decided to try to shoot for something in between. I overweight RioCan but not to the extent of XRE but underweight some of the smaller REITs as I’m not comfortable giving them the equal weight of ZRE.

    Third consideration is the corelation between REITs is far closer than that of a couple of other listed companies. e.g. RioCan and Dundee do tend to move more or less in tandem; Encana and Royal Bank do so to a far lesser extent. (There are exceptions, of course, such as H&R which tanked for a while with the Bow situation in Calgary) As such, I don’t need to worry too much about “rebalancing” per se. When I have excess funds from distributions, I find one or two REITs that looking to have become ‘underweighted’ – or perhaps consider adding a 12th to the portfolio – and spend another $6.95 to top up my REIT holdings.

    For smaller portfolios, yes, the decision isn’t quite so straightforward and the points you make are all very valid.

  3. Canadian Couch Potato October 10, 2012 at 11:18 am

    @Jon Evan: Thanks for an excellent point. It’s hard enough resisting active decisions with six or seven ETFs. The decision becomes a lot harder when you’re juggling dozens of individual stocks, some of which may be on a big run. If you’re going to think about unbundling, you need to make sure you have a lot of discipline—and let’s face it, many of us do not.

    @Mark: Very interesting—you’re in exactly the position where unbundling may indeed make sense. You could make quarterly rebalancing trades with each REIT every year and still come out way ahead compared with an ETF’s management fee, which would be almost $1,000 annually.

    To answer your question about XRE versus ZRE, I recommend the latter in my model portfolios because I think cap-weighting in small sector ETFs leads to too much single-stock risk. More than 40% of XRE is made up of just three REITs, which bothers me. (This is a Canadian problem not shared by US investors: the Vanguard REIT fund has over 100 holdings.) Your strategy of finding a middle ground sounds just fine, as long as it doesn’t lead to the problem Jon Evan mentions above. :)

  4. Andrew F October 10, 2012 at 3:45 pm

    I’m still waiting to find out how many holdings the Vanguard fund will have. If it is still the pathetic number held by XRE or even ZRE, I still see some merit in unbundling, though the lower MER hurts the case. 0.35 bps would be about $500 for the $160k REIT allocation mentioned above. Worth some effort, but the complexity of managing more than 10 positions? I’m not so sure.

    Another thing to keep in mind is that REITs are particularly annoying in taxable accounts. Much more paperwork to keep track of in terms of ROC, and tracking changes in cost basis.

  5. Jeff October 10, 2012 at 7:51 pm

    I was thinking of unbundling REITS in my TFSA accounts. Combined with my wife, we will have a little over $50 K each in space next year. If we invest $5 k per stock, we would have 10 stocks in total. I think that this would enough diversification for this asset class? We would only rebalance once a year as we get more TFSA room from the government. We would either buy a new REIT altogether or put all of the money in the REIT at the lowest value. It may not be as re-balanced as an ETF, but I wonder if that matters as much. I would apprecaite your thoughts.

  6. Paul G. October 10, 2012 at 8:01 pm

    One upside to unbundling is that an investor who likes to DRIP could get a DRIP discount on some REITs, which increases the value of distributions.

    Once my ZRE gets to be worth 3 REITs (in sufficient amounts to DRIP) I know I’ll be tempted to unbundle and take a risk with less diversification for this part of my portfolio.

  7. PhilippeV. October 10, 2012 at 9:22 pm

    Thank you Dan and to all the others who commented on my question, your insights are most helpful.

    I would like to point that indeed in this case it would be for a RSP account and my time horizon would be over 20 years. I am still trying to decide the exact amount in relation to my overall asset allocation, one thing is for sure, it would not be a core asset.

    A few things I would point out. I would approach it like Jeff pointed out. This would minimise trading costs greatly as a few new REITs would be added once in a while to maintain overall asset allocation. Tracking error could be large, but I am prepared to live with it since I would be compensated with lower costs.

    Jon Evan makes a very good point about spending time on the couch vs. the screen. The method I would use to buy the REITs would be passive in the sense that I would aim to have as many different REITs as possible and once I would hold all the index constituents then I would aim for a compromise between equal weight and market cap –as mentioned by Mark.

    In the end will I be richer unbundling the ETF for Canadian REITs, I do not know because of the uncertainty on tracking error. But the math shows with certainty that my costs will be lower.

  8. Jesse October 10, 2012 at 9:40 pm

    Something that is only alluded to in the above comments that I thought I would unpack a little.

    i.) Many studies show that the performance of different sectors drives most of the returns on equities, and that differences between companies within sectors is minimal. Thus, you do not need to own *every* REIT to capture most of the benefits of being exposed to REITs.

    ii.) Any REIT ETF that weights REITs according to market cap will be dominated by a few of the larger players. Thus, in XRE, the top 3 REITs account for 40% of the fund. In other words, dropping out the three, five or even ten smallest funds will have little impact on whether you can track total returns for the sector.

    iii.) It is important to consider how you are actually diversifying. It may make sense to ensure that you have REITs that cover different provinces, and/or types of property, but there is no need to jump into the third or fourth REIT fighting for the Toronto Office Space market

    iv.) A lot of the benefits of indexing come from the difficulty of picking winners in businesses that are difficult to understand or will change in unpredictable ways in the future. REITs seem to be more directly comparable with each other, meaning that if there was a space in which one can pick winners, this would be the place.

  9. Canadian Couch Potato October 10, 2012 at 10:19 pm

    @Philippe: Glad if this helped you with your decision. Thanks for the interesting question.

    @Jesse: I think you’ve made a lot of assertions that sound reasonable on the surface, but I’d like to see the evidence to back them up. Where are the studies that show there are minimal differences between companies in the same sector? Of course there will be a high correlation, but I think we can all agree that there’s a difference between GM and Toyota, or between CIBC and TD. It’s not like you could have picked any of these companies at random and expected them to perform comparably.

    If you want to be a stock-picker, that’s fine, but I don’t think it’s what Philippe wants: he’s hoping to get exposure to the whole asset class, and to do that he needs to have at least 15 holdings or so to minimize the impact of any single company.

  10. david October 10, 2012 at 11:37 pm

    Thank you for this informative and timely discussion. I am about to investing 50K to 70K in my first REIT and weighing the pros and cons of an ETF vs buying the individual REITs. The math indicates substantial cost savings to the latter option but I am not clear on how one can easily calculate a compromise between market cap and equal weight for each REIT?

  11. Philippe V. October 11, 2012 at 11:54 am

    @David: could you elaborate a little bit more on calculating a compromise between market cap and equal weighting.

    The way I see it, you look at the allocation of each REITs in your holdings and then determine their weight. Then compare with the weight in a market cap index and the weight of an equal weighted index. When I would add positions to keep overall asset allocation, I would then add an REIT to get closer to a hybrid of equal and market cap weighting. In this case I am adding one REIT at the time so I would just spot the biggest discrepency and try to correct it. It’s judgement but based on numbers with the pre-determined rules just mentioned.

  12. Doug Cronk October 11, 2012 at 1:40 pm

    Individuals may ‘aim’ to replicate an ETF/index but always our behaviour gets in the way and we make decisions like: I don’t like that one, I like that one more (so maybe I’ll substitute), which REIT do I buy, which one do I not, how will I do credit (or any) analysis, how will I know which and when to sell, once I’ve bought the individual pieces how will I re-balance to ETF weight as weights change over time … etc. If you could stick to the ETF/index weights, you are a unique investor.
    Further, with individual holdings you may receive ‘pieces’ of distributions that may result in a bunch of ‘spare change’ sitting in cash (very bad with interest rates so low) instead of re-investing distributions at the ETF level.

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  15. John October 14, 2012 at 7:32 pm

    Most websites and discussions focus on either investing in ETFs or stocks but rarely both. Personally, I believe that a mix is often in order and it’s what I do with REITs. Buy an index (ZRE in my case) then buy a few “satellites” (i.e. a few or your favourites). It’s not passive nor is it active.

    An average investor… John

  16. Just Learning December 1, 2012 at 10:16 pm

    At 10$ a trade for someone who is saving regularly with a 10 time horizon, what would consider to be a minimum purchase size? 2.5k, 5k, 10k? Thanks again for all your valuable insights.

  17. Canadian Couch Potato December 1, 2012 at 10:26 pm

    @Just Learning: In terms of individual transactions, my rule of thumb is no more than 1%. So if you’re paying $10, I’d suggest never transacting for less than $1,000. But the more important thing to consider is the number of these transactions per year relative to your portfolio size. If you have a $10,000 portfolio, you should not be making 10 or 12 transactions a year. That’s why I typically recommend index mutual funds for accounts less than $50,000 or so.

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