That sound you just heard was the latest shot fired in Canada’s ETF price war. iShares has just slashed the management fees on several popular equity and bond ETFs—and just like that the country’s oldest ETF provider has become the cheapest in many categories.
BlackRock has rebranded nine ETFs as the iShares Core Series, “a suite of funds covering key asset classes.” A balanced portfolio of these ETFs now has a weighted management fee of just 0.12% or so, less than half the former cost. (As a rule of thumb, expect the full MERs to be 8% to 10% higher due to taxes.) Here’s what a traditional Couch Potato portfolio might look like when assembled from the Core Series ETFs:
ETF name | Allocation | Old fee | New fee |
iShares S&P/TSX Capped Composite (XIC) | 20% | 0.25% | 0.05% |
iShares S&P 500 (XUS) | 20% | 0.14% | 0.10% |
iShares MSCI EAFE IMI (XEF) | 15% | 0.30% | 0.20% |
iShares MSCI Emerging Markets IMI (XEC) | 5% | 0.35% | 0.25% |
iShares High Quality Canadian Bond (CAB) | 40% | 0.30% | 0.12% |
Total | 100% | 0.26% | 0.12% |
The cost of competition
BlackRock launched a family of Core iShares ETFs in the US back in October 2012. They identified 10 broadly diversified ETFs (as opposed to the dozens of narrowly focused products in their lineup), gave them new names to stress their role as the building blocks of a long-term portfolio, and lowered their costs. At the time a prominent observer noted that iShares had to make a move because it had been “a bit out of the game.” They were losing assets to Vanguard, Schwab and other providers who were undercutting them on fees.
You could say the same thing about BlackRock’s Canadian ETF lineup, which was in danger of becoming obsolete. iShares used to have the market all to itself, and at the end of February they still held about two-thirds of all ETF assets in Canada, but its competitors have been steadily eroding that market share. According to the Canadian ETF Association, Vanguard boosted its assets under management by $310 million in the first two months of this year, while BMO added $215 million. BlackRock, meanwhile, saw net outflows of $512 million, at least partly because the relatively high management fees on some of its older ETFs were increasingly hard to justify.
With the creation of the Core Series, however, iShares is now the the cost leader in several major asset classes:
- Canadian equities: XIC is now one of the cheapest ETFs in the country, with an annual cost of one shiny nickel per $100 invested. The BMO S&P/TSX Capped Composite (ZCN), which tracks the same index, carries a fee of 0.15%, while the similar Vanguard FTSE Canada All Cap (VCN) comes in at 0.12%.
- US equities: XUS now has a lower fee than the virtually identical BMO S&P 500 (ZSP) and Vanguard S&P 500 (VFV), both of which charge 0.15%. BlackRock also lowered the fee to 0.10% on XSP, the hedged version of its S&P 500 ETF.
- International equities: The total-market ETFs covering developed and emerging markets (XEF and XEC) now have lower fees than the Vanguard FTSE Developed ex North America (VDU) and the Vanguard FTSE Emerging Markets (VEE), which track similar indexes. BMO’s offerings in international equities are even less competitive on fees, though the recently launched BMO MSCI EAFE Index ETF (ZEA) does have a more tax-friendly structure.
- Bonds: The iShares High Quality Canadian Bond (CAB) is now the cheapest broad-based bond ETF, sharply undercutting the BMO Aggregate Bond (ZAG) and the Vanguard Canadian Aggregate Bond (VAB), which carry management fees of 0.20%.
A few question marks
The choice of CAB as a Core product is surprising: one might have expected the Core bond ETF to be the iShares DEX Universe Bond (XBB) instead. The granddaddy of fixed-income ETFs has an MER of 0.33%—much higher than its competitors—and is a prime candidate for a fee reduction.
In an interview, Mary Anne Wiley, Head of iShares Canada at BlackRock, explained the choice: “We’re building this for the future, but we’re mindful of who is there today, and what they’re looking for. That fund [XBB] is $1.5 billion, and a lot of investors are there for different reasons. Some are buy-and-hold, but others are using it to position their bond portfolio in a way that is more short-term in nature. Institutions are using that fund, and they’re valuing a couple of different things” other than low MER, such as liquidity and trading volume.
There’s nothing wrong with using CAB as a core bond holding so long as investors understand it. Until recently it was one of iShares “Advantaged” ETFs, which used a complicated structure to recharacterize interest income in a tax-friendly way. When the federal government cracked down on these structures, CAB became a traditional bond fund with 60% government and 40% corporate bonds, all investment-grade. By contrast, ZAG holds about 30% corporates, and while VAB holds just 20%, so the iShares fund has a higher coupon and slightly lower duration, but also a bit more risk.
There are a few oddball choices in the Core lineup: the iShares S&P/TSX Equity Income (XEI) holds 75 Canadian dividend stocks, which I would not even consider a discrete asset class. The iShares Canadian Short Term Corporate + Maple Bond (XSH) is also too specialized to qualify as a core fixed income holding. (A maple bond is issued in Canadian dollars by a foreign corporation.) Rounding out the Core list is the iShares DEX Long-Term Bond (XLB), which is likely to have more appeal for institutional investors. Wiley suggests these three Core fixed income ETFs can be combined to achieve whatever duration investors want in their portfolio.
Itching to switch
Whenever there’s a new product launch or a fee reduction like this, I get a wave of emails from investors who are itching to sell their current holdings to embrace the new ETFs. (Then they ask if I plan to change the recommendations in my model portfolios.) I remind them to keep cost reductions in perspective: low MERs are wonderful, but small differences are often trivial, especially when weighed against transaction costs.
Say you have a $20,000 holding in the Vanguard FTSE Canada All Cap (VCN) and you want to switch to XIC to save 0.07% in management fees. That works out to an annual savings of just $14. If you make two trades at $10 apiece and lose another $10 or $12 on the bid-ask spreads it would take more than two years to break even. If you’re investing in a taxable account and sitting on a capital gain, switching makes even less sense.
It will be interesting to see how Vanguard and BMO respond to this move. But even if the ETF providers call a truce in the price war it’s fair to say Canadian investors are finally getting access to enjoy the pricing that our neighbours in US have enjoyed for many years.
Outstanding! XIC has been my core Canadian holding for some time, and in the past year I had begun to consider replacing this with VCN/ZCN as their fees were measurably lower. iShares just retained that portion of my business & saved me a trade. :)
Hi Dan,
Thanks for a great post. I am 28 and just started in the world of investing for my future, I feel very lucky that i’ve come across the index investing strategy early on in my wealth building years. In your article you mentioned that it wouldn’t make a huge difference to switch the these lower MER’s offered by Blackrock if your moving money from a different portfolio, say TD e series. I’m wondering if in general you would recommend trying these new ETF fees for a new couch potato that doesn’t have a portfolio to switch and wouldn’t incur the initial transaction costs of switching? Thanks for any input.
With this latest round of changes, I also noticed that XBB changed the index that it follows (DEX Universe to FTSE TMX Canada Universe).
@Lost: I still like the e-Series funds for new investors with smaller portfolios because they are much more user-friendly. For someone making the move to ETFs, these iShares funds are excellent core holdings with very competitive costs. But I’m taking a wait and see approach with CAB for now.
@B: This just a change of ownership and name, not a change in strategy. FTSE bought the DEX indexes:
http://www.etfstrategy.co.uk/ftse-and-tmx-combine-fixed-income-index-businesses-joint-venture-to-compete-against-barclays-and-markit-iboxx-32121/
I noticed on the iShares website this announcement as well: http://ca.ishares.com/content/stream.jsp?url=/content/en_ca/repository/resource/press_release/pr_2014_03_24a_en.pdf&mimeType=application/pdf
It seems to say that they may start holding individual securities directly instead of only holding the equivalent US ETF (they mention in the release that can also hold other Blackrock ETFs). This seems to apply to several of their ETFs, including XEF and XEC.
This would seem to match the advantage of ZEA (and at a lower cost to boot).
Hi Dan,
I’m just starting up with investing and want to dive right into ETFs as TDW is offering 30 commission-free trades on new accounts. Do you recommend any of these iShare Core Series ETFs over ones listed under your Option #4 Global Couch Potato portfolio? For example, should I be purchasing XIC rather than VCN?
Thanks
CAB is also commission free on Qtrade.
Great news! Will you now recommend XIC instead of VCN for the Couch Potato portfolios? Is XIC simply a cheaper version of VCN?
This would have been great to know before I bought more ZCN yesterday! At least I have another purchase planned so I can take advantage of the lower fees.
The reduction in CAB’s fees is great news for investors. Given the low yields on bonds an MER o.3 – 0.5% is not much help. Regarding XBB I can’t tell if the real reason it wasn’t included is due to the operation costs being higher from short-term trading or because it’s generating a lot of fees that will compensate for these other cuts. Either way I’ll have to give CAB a closer look once bond yields rise some more.
It looks like CAB’s yield is 0.2% lower than XBB which seems strange since it holds more corporate bonds. Maybe it’s because of the shorter duration?
In order to get the lower fee, do you need to sell your position and re-purchase it, or does every shareholder of the respective ETF automatically receive the lower MER?
Thanks!
Just a reminder to re-read the last paragraph of this post. No, I am not suggesting everyone rush out and switch ETFs. As I’ve tried to stress many times, small differences in fees mean very little in small portfolios.
@Poppa Tom: For the record, CAB is also free at Scotia iTRADE, but the decision to choose one ETF over another should be based on strategy, not on trading commissions. Make sure CAB is appropriate for your portfolio: some investors may find it too heavy in corporate bonds.
@James: No, you don’t need to repurchase the ETF if you already own it. The new fee will be applied to all units immediately.
Dan,
What would you recommend to first time investors deciding to start with ETFs rather than the e-Series index funds?
Ishares is confusing investors! XEI: a core asset class? Surely this is a specialty etf and I’m not sure in whose portfolio it belongs? Now it’s fair to say that REITs are a separate asset class but XEI is a hybrid of dividend equities and REITs. Who would use this etf Dan?
This makes me want to switch from XEM to XEF. Are these two funds sufficiently different that I would not get in trouble with CRA if I was in a capital loss position?
Hey Dan – just one Q: you mentioned about the ‘full MER’, which I get. However, do your recommended portfolios (different section) account for this, or would the other hidden costs be on top of this?
Reason I ask is that the .12% above seems quite a bit lower than some of your recommended portfolios – agreed that if someone already holds the latter, they should not run out and incur costs to switch it up. However, if one is just starting out …. ?
@P and LT Smash: As long as you stick to the core asset classes and keep your fees low it really makes very little difference which ETF provider you use.
@harveyM: iShares seems to be positioning its Core Series as ETFs suitable for long-term buy and hold investors. I suppose a fund like XEI fits that description, but I would agree it would be hard to justify it as a core holding. You can make a much stronger argument for REITs being a discrete asset class.
@Zaphod: Yes, the two indexes are different enough that they would not be considered “identical property.”
when will mutual funds have lower fees?
Just wondering if you have any insight as to if and when Vanguard and BMO will respond to this move? The best case scenario would be that they immediately match or better these changes in their ETFs. Presumably they won’t issue a press release indicating that they are not going to match these changes. But I would guess that if in a few months, or years, they start seeing outflows in their competing funds they would match or better these reductions.
Great post.
When will the new MER’s be applied to their ETF’s? I checked the MER of XIC today at 0.27% with no indication of when the price change will take place.
This lowering in price bolds well for indexers across the board.
You do us all a great service with up to date information like this. Thanks for passing it along.
@ CPP
Do you expect competitors to react to the fee reduction and slash their prices as well?
No point in switching really if my current holdings end up around the same price.
Is it a reasonable assumption in your opinion?
Best,
HD
@Tennis Lover and HD: I have no insight into whether the other ETF providers will respond directly to this move. My guess is they won’t do anything in the short-term. Let’s remember it was Vanguard and BMO who led the move to lower fees and iShares was a bit late to the party.
@Superior John: The new fees should be effective immediately, and they were on the iShares website yesterday. They seem to be having a little trouble with their site today.
If someone were to add new money to their portfolio today, should their new purchases be in whatever is cheapest, or is there any particular reason to buy more of what they hold? For example, if I hold ZCN and am buying more Canadian equity, would there be any reason to pass over XIC and buy more ZCN instead?
Thanks.
This is interesting. But as Dan points out the benefits may only be marginal in many contexts. I am anticipating something else…
It will become really interesting when the ETF providers all offer more lower cost ETFs AND bundle them in uncomplicated structures, something like ING Streetwise funds or a version of the venerable Complete Couch Potato, rebalancing for an additional 10-20 basis points. Add in SIPs and DRIPs and SWPs and were off to the races!
That could shake things up.
@Tyler: I always suggest doing the math and learning the actual dollar amounts. Let’s say you add $2,000 to Canadian equities this year. The management fee on ZCN is 0.15%, so that’s $3 on a $2,000 holding. If you put that money into XIC the fee would be $1 a year. Do you want to manage two ETFs instead of one to save $2?
@Andrew – while it seems simple to have all the asset classes bundled into a single fund there is a major disadvantage to these at withdrawal time. Keeping the asset classes separate allows you to avoid withdrawing from any severely undervalued asset classes at the time.
E.g. Lets say at retirement time there is a stock crash and your equities lose 30% of their value while the bonds keep their value. Which asset class would you withdraw your first retirement money from? (Seeing that will be withdrawing your investments over 20+ years)
Does anyone know if iShares/BMO/Vanguard have any plans on putting out an etf that combines their etfs in a blended fashionto allow a single purchase to buy all at once without concerns about rebalancing, as the ING Streetwise funds do
Can someone please explain me as to when does it make sense to buy CAB and when to buy XBB?
Apologies for the horrendous sentence structure in the post above.
What are your thoughts on VUN vs. XUS? VUN is more diversified and holds a lot more companies, but is that worth the slightly higher fee? (Note: I’m not thinking about switching, I’m planning on making a new purchase.)
What is puzzling me is the difference in returns between XBB and CAB. Over the past few years XBB seems to have had a consistently higher return than CAB. CAB has a shorter duration than XBB, so does this explain the difference? Does this also suggest that CAB won’t get spanked as badly when interest rates start to rise?
I am fairly close to retirement and I have a substantial investment in bond ETFs; mainly XBB. I’m not too worried about short term volatility as I am planning a long retirement ;). As a result the lower fees of CAB probably do justify moving at least some money over there as long as the long term total returns (before fees) are comparable. Any thoughts?
Thanks for sharing how you would think in considering the purchase of new assets, CCP.
Al and Andrew… are you thinking of something along the lines of CBN or CBD, which attempt to offer a balanced fund of funds?
@Dennis: Past returns on CAB should be more or less ignored. The fund recently changed its mandate: previously it used a complicated forward structure as a way of improving its tax-efficiency. It didn’t even hold bonds directly, and it carried an additional cost of about 0.50% (not included in the MER) to pay for the forward structure. That likely explains much of the performance difference between CAB and XBB in the past. Going forward I would expect CAB would have a slightly higher expected return (with a bit more risk), given its lower fee and greater allocation to corporate bonds, but that remains to be seen.
@Tyler and Al: I’ve thought about this “ETF balanced fund” a lot, but I actually think ETFs are the wrong structure. The benefits of a balanced mutual fund include not having to open a discount brokerage account, automatic monthly contributions, full reinvestment of dividends (including partial shares), ease of trading etc. ETFs have none of these qualities. Even in the States you’ll notice there are very few target date ETFs or “ETF balanced funds,” because they don’t seem to have much appeal. The mutual fund structure is better for these, in my opinion.
Hi,
I wonder how those lower fees affect the strategy of buying US based ETFs. How much direct USD exposure should Canadians investors seek when there’s no longer a need to look for lower fees overseas? Should it be 30, 40 or 50% of the equity portion of the portfolio? I think I saw a spreadsheet calculating and comparing all this on the blog but I can’t remember where.
Question is why won’t ‘the actively-managed mutual fund industry respond? They don’t recognize the threat to their business. Especially with new regulations on the way.
Wouldn’t Ishares CBD or CBN etf be an example of an “etf balanced fund”?
Not sure who would want these however with the complex exotic asset mix which might change over time plus the high MERs?
quick question, dividend etf xdv or vdy ?
@HarveyM: My thoughts exactly about CBD and CBN. No one seems willing to create a plain-vanilla balanced ETF with a low fee.
Hello,
I currently have a small e-series portfolio and am wondering what $ amount would it really start to make sense to switch? I imagine with my current portfolio size ~10k it wouldn’t make much sense.
Thank you,
David
@David: I get asked this question all the time and I usually try to discourage inventors from switching to ETFs too quickly. The e-Series funds are an excellent choice, and they’re much more user-friendly than ETFs. We have often used them for DIY clients with portfolios as large as $300K to $400K.
The difference in MERs is significant: ETFs can lower your cost by about 0.25% of so. But this works out to just $25 a year for every $10K invested, and many people are willing to incur that cost for the many conveniences.
https://canadiancouchpotato.com/2013/02/19/why-index-mutual-funds-still-have-a-place/
Thank you for taking the time to answer me.
Yes, I would never switch with only 10k, the hassle of the transfer definitely outweighs the pro’s for me. I was personally thinking that when I am closer to $50-75k would it start to make more sense but wanted to hear your thoughts.
You mentioned having DIY clients using the e-series funds with portfolios as large as $300-400k. Would you still suggest this with the option of these new funds?
Thanks,
David
@David: It may be worth considering ETFs once you reach the $50K to $75K range. This will be of interest:
https://canadiancouchpotato.com/2012/07/30/comparing-the-costs-of-index-funds-and-etfs/
Regrading whether the new lower fees on these iShares ETFs would affect the decision, my answer would be definitely not. They really don’t change anything fundamental.
@David
By being invested in eSeries funds you have already dramatically lowered your costs compared to the average investor. Sure eSeries might be costing you an additional $25/year/$10000 invested over an ETF approach, but you are already saving $200/year/$10000 invested over the average managed mutual fund.
When you are ready to make the leap to ETFs, you’ll know.
Is a 50/50 of xic and cab good for long term? what would the return be?
@CCP (And anyone who feels like answering this!)
I am surprised by how the readers on this site (long term, DIY, index investors) seem to be embracing iShares over these reductions. I am quite a big fan of Vanguard, so this is likely biased. In 2011, I believe iShares was offering only currency hedged, fairly high (approx .5%) MER funds, overall not well suited for the indexed crowd. They were offering products almost as exotic as Horizons just a few years ago, many of which still exist. What changed? From my vantage point, probably Vanguard. Is there not an urge for investors to embrace the company who initiates competition, rather than grudgingly responding to it?
Also the choice of FTSE indexes is a great move. Some investors who are likely young (TFSA room and RRSP room are maxed, but still in accumulating stage of investing cycle), it is a difficult to beat Vanguard if you are using E-series to accumulate in non-Registered, then dropping into registered accounts and using Vanguard to (potentially) avoid superficial losses and offset future/past capital gains. The potential tax savings can far exceed any difference MER would have on portfolio performance.
Maybe I am holding too big of a grudge, but when this blog started, to build a similar portfolio to the E-series using iShares funds, I do believe that it would have been required to have a portfolio well into the six digit range for lower MER’s to overcome the costs of annual rebalancing. Also, these were Canadian domiciled versions of US funds, so I do believe foreign withholding taxes would have made them MORE expensive!
Hey folks,
Which REIT would you add to this cheaper i-Shares group of ETFs?
Thanks!
@Adam: I agree it’s fair to say that Vanguard has bean the leader in driving fees down in Canada, just as they have been in other markets. BMO has also been quite aggressive in it its pricing. What iShares has done in this latest move is welcome, but it might have come a lot earlier.
Should one switch out XIU for XIC? I have some free trades available to me.
Hi CCP,
I’m currently looking to move out of my ridiculously high 2.17% MER mutual fund from BNS, and into ETF portfolio.
I’m willing to take on more risk with my investment, as I plan to hold for a significant amount of time, 30+ years. Would the following fund allocation make sense to you? I’m in my mid twenties, and following a rough guideline of bonds to age.
iShares S&P/TSX Capped Composite (XIC) 25%
iShares S&P 500 (XUS) 25%
iShares MSCI EAFE IMI (XEF) 20%
iShares MSCI Emerging Markets IMI (XEC) 10%
iShares High Quality Canadian Bond (CAB) 20%
Questrade now has commission free purchasing, so I don’t see the negatives of creating an ETF portfolio vs ING Streetwise fund, other than the investment of my time managing the seperate funds.
@ Kerplar:
3 comments:
1) XUS, XEF, and XEC are all relatively new funds (in their Canadian wrapper versions) – less than a year old – with new investment strategies announced at the same time as the fee reductions to which Dan refers. They may well turn out to be be fine, low cost funds (XEF and XEC in particular could provide very useful options for EAFE/ emerging markets investing), but it is really too soon to know for sure how well they will track their indexes. I’d wait until they have a longer track record – say 2 years, in April 2015. YMMV
2) You have XUS + XEF + XEC = 55% of your portfolio. Are you sure you want that degree of foreign currency exposure? Unless you have a reason to hedge against a general and sustained depreciation of the Canadian dollar, it seems on the high side to me. Again, YMMV
3) You say you’re in your mid 20s, and apparently only invested in a single high cost mutual fund. That implies your portfolio is not yet very large (my apologies if I’m wrong). If so, then why not start your DIY indexing career with TD eFunds? In his “Model Portfolios” Dan has a plan using 4 TD eFunds that you can adjust as you wish (you only lose emerging markets exposure). When your portfolio is larger, and crucially you have more experience with asset allocations, you can transfer your holdings to ETFs – in the interim you will still capture most of the cost differential with that high cost POS you have now, and you’ll get a feel for what works for you.