Your Complete Guide to Index Investing with Dan Bortolotti

An Interview With Wealthsimple: Part 2

2017-12-02T23:16:56+00:00October 16th, 2014|Categories: Asset Classes, Discount brokers, New products|Tags: , |25 Comments

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.

iShares Core S&P/TSX Capped Composite (XIC)
Vanguard Total Stock Market ETF (VTI)
iShares Core MSCI Emerging Markets ETF (IEMG)

We are using US-listed ETFs wherever possible. As you have written about on your blog, the tax efficiency is better. We have been able to negotiate institutional currency pricing. The typical investor pays 100 to 150 basis points on top of whatever the foreign exchange rate is through their discount brokerage or their advisor. We have been able to negotiate a rate of 0.2%, and that will come down as we scale the business.

I understand that you don’t use cap-weighted funds for the other equity asset classes.

DN: With the real estate and dividend stocks we use a fundamental methodology. We really want to make sure the underlying fundamentals are considered when looking at income-producing stocks. Obviously the risk to a dividend-paying stock is that the dividend will be cut, so the highest yield is not necessarily the best, especially given a rising interest rate environment. We want companies that are paying solid income and growing their distributions over time, so we have gone with a more fundamental methodology there.

For real estate we’re using the Purpose Duration Hedged Real Estate Fund. When you look at the real estate products on the market, the iShares product has a third of the portfolio in two stocks, so arguably you’re taking a lot of company-specific risk there. We prefer the BMO fund because of the equal-weight structure, but even there you’re missing out on the US. So Purpose gave us the ability to get exposure to both Canada and the US, and it looks at the underlying fundamentals of the businesses. The other interesting thing is the income received from the US is recharacterized as Canadian dividends for tax purposes: it’s part of the corporate class structure Purpose uses.

We actually use the mutual fund versions with Purpose, rather than the ETFs. Mutual funds in Canada have been associated with very high management fees, and that’s why people generally don’t like them. But one of the beneficial things about the mutual fund structure is that you are not paying a bid-ask spread like you would with an ETF: you are getting it at net asset value every day. Because we buy our securities once a day the mutual fund structure is actually cheaper, because we are not paying that bid-ask spread. And at Purpose the management fees on the mutual fund and ETF versions are exactly the same. So we just made that call based on efficiency.

The dividend fund also has a North American focus. The problem with Canadian dividend ETFs is simply that you have a massive overweight to financials, and obviously you miss out on the US market completely. So we have elected to go with the Purpose Core Dividend Fund, which has a sector cap of 20%. It also has that ability to recharacterize US income as Canadian dividends through the corporate class structure.

The tactical stock piece is really interesting, and we’re excited about it. The Purpose Tactical Hedged Equity Fund uses a US fundamental methodology for the individual stock selection, but the ETF itself can go anywhere from 75% to 25% long the market. It’s all rules-based: they look at technicals from two weeks to one year. When we add a sliver of that to the portfolio it really dampens the volatility and provides what we believe to be superior risk-adjusted returns, because you’re systematically trimming that equity exposure when markets start to fall. So we have about a 10% weighting to that fund, and we think that’s going to help us on downside protection.

The flexibility we have by owning a few of the Purpose products is the tax deferral mechanism within the corporate class structure. If we need to rebalance by reducing our equities and buying more fixed income, for example, instead of selling the equity exposure we can just roll it over into the fixed income fund within the corporate structure and defer capital gains. So from a tax-efficiency standpoint it’s a huge advantage.

OK, that’s the equities looked after. Now let’s talk about the fixed-income side of the portfolio.

DN: For Canadian investment-grade bonds we’re using the iShares 1-5 Year Laddered Corporate Bond (CBO), and then we overlay that with the Purpose Total Return Bond Fund, which is more tactical in nature: it can have a weighting of up to 66% in any one of four categories: high-yield, investment-grade corporates, governments, or cash.

We are heading into a new paradigm of interest rates. We’re not going to make a call on interest rates on a short-term basis, but given the record low rates, they really have only one place to go, which is up. So for the fixed-income piece it’s important to keep the duration low. We’re not going to make any active duration calls, because we think that could become very volatile, similar to last year when interest rates spiked and no one really saw it coming. So we’ve elected to stay short and be a little more tactical.

On the equity side, nothing is hedged to the Canadian dollar. But the US bonds are all hedged: we own the iShares U.S. High Yield Bond CAD-Hedged (XHY). The reason we go to the US for that exposure is simply because there is a very small high-yield market in Canada and it’s just much more robust in the US.

So for a typical balanced portfolio, what would you estimate is the weighted MER?

DN: It’s about 0.25% to 0.30% across the board. We’re never going to be the lowest cost, but we want to provide people with a sophisticated investment solution at a reasonable cost. And given where management fees are on mutual funds and active management today, we feel we’ve achieved that.


  1. françois October 16, 2014 at 5:56 pm

    thanks Dan. Interesting service. Funny, i have been reading so much CCP stuff recently, that i read this article and see all this managing stuff and asset class calls (like the Purpose Tactical Bond), and go wow this is weird..

  2. MrMoxy October 16, 2014 at 7:43 pm

    The WealthSimple platform is both interesting and needed. Further, they seem to have done their due diligence in the areas you covered.

    BUT, having gone to the site and played with the risk assessment/portfolio construction questionnaire, I would have very serious reservations about sending an unsophisticated person there.

    No matter what set to parameters you put in, you seem to always get a VERY equity heavy allocation. This is true even for the very conservative investor. The result is high risk for risk averse people, who are likely not be savy enough to know it. This is wholly inappropriate IMO. Try it and see.

    SO, would I put my money there? Maybe but only with an explicit allocation. Not many are up to that.

    A great platform idea but it needs work…I was disappointed.

  3. Tristan October 16, 2014 at 8:20 pm

    I think I prefer a passive index strategy using low cost cap weighted ETFs/index funds.

  4. Willy October 16, 2014 at 8:52 pm

    First I’ve heard of the Purpose Duration Hedged Real Estate Fund. Seems interesting – more diversified than ZRE (which I use, and fully agree with the noted issues with cap-weighted XRE). And the recharacterization of US income is interesting. Maybe worthy of one of your “Under the Hood” posts?

  5. Ian October 16, 2014 at 11:16 pm

    “The typical investor pays 100 to 150 basis points on top of whatever the foreign exchange rate is through their discount brokerage or their advisor”

    hmm… 1-1.5% higher foreign exchange charge than with your brokerage? Seems sneaky. Any logical reason why they would charge so much for this?

    This really looks like a hidden fee whose purpose is to hide the real cost from the consumer… or am I misunderstanding something?

  6. John October 16, 2014 at 11:41 pm

    He’s saying they are cheaper than a typical brokerage/advisor, which is true. The next sentence however, is laughable. I can convert $10,000 for $3.50 (.035%) (including bid-ask spread and commission, and it gets slightly cheaper with bigger numbers) in a standard interactive brokers account, and he’s touting .2% (almost 6 times more expensive) as an amazing “institutional rate”.

    This still seems like a good option for a lot of people, but the above rubs me the wrong way. Some of the information website also seems amateurish/incorrect.

  7. Chris October 17, 2014 at 7:22 am

    How does Wealthfront’s pricing work? Is the fee quoted on their website on top of the underlying ETFs, or is it an all-inclusive fee? It sounds from the website like it’s all-inclusive, in which case this debate about currency exchange fees is moot — the customer isn’t exposed to it.

    If their prices are all-inclusive, this is a reasonably good deal, especially since they automatically take care of tax loss harvesting.

  8. Canadian Couch Potato October 17, 2014 at 8:47 am

    @Willy: Personally, if I were looking for North American REIT exposure I would simply combine Canadian and US ETF (such as ZRE and VNQ) and I would hold it in an RRSP. I don’t have a lot of confidence in products that “recharacterize” income. There has to be a cost to doing this.

    @Ian and John: It is very common discount brokerages to charge spreads of 100 to 150 bps on currency exchange. If Interactive Brokers charges a spread of 3.5 bps that’s an extraordinarily good rate that I have never seen anywhere else. But let’s acknowledge that IB is not an appropriate platform for most index investors, and certainly not for the target market of firms like Wealthsimple. (They do not even offer registered accounts.) My guess is that IB uses currency exchange as a loss leader to attract active traders.

    @Chris: Did you mean Wealthsimple (as opposed to Wealthfront)? If so, then Wealthsimple’s fee is on top of the underlying ETF fees. So if the weighted MER of the funds is about 0.30%, then the typical investor would pay another 0.50% on top of that for a total of 0.80%. And for the record they are not doing tax-loss harvesting yet, though they plan to introduce it in the near future.

  9. Wox October 17, 2014 at 9:09 am

    The way you convert funds in Interactive Brokers is with a forex trade so I don’t think it’s a loss leader, I think it’s just designed for forex traders. Also, their charge is even less as it’d only cost you half the bid-ask spread on a conversion. It’s 0.2 basis points with $2 min commission and the bid ask spread is usually 1 basis point on CAD.USD so if you convert $100k it’d cost you ~$7 (.007%).

    I’d agree IB is probably not suitable for most index investor, but I also wouldnt tout 0.200% as a competitive institutional rate.

  10. Andre October 17, 2014 at 12:18 pm

    I Dan,
    I often hear about long term superiority of small cap stocks. Particularly of small cap value stocks. What are your thoughts on that and are there any etfs sold on the TSX (in $CA) that replicate a US/Intl small cap value index?

  11. Paul October 17, 2014 at 12:51 pm


    First off, WealthSimple is a great idea and I wish you all the best. I’m certain it will be very successful.

    One point: DN says “We’re never going to be the lowest cost” in a recent interview, but the Pricing page on the website says “Pricing (a lot less than everyone else)”.

    Which one is it?

    – Paul

  12. Jeff October 17, 2014 at 1:22 pm

    CCP, would you consider VNQI along with VNQ and ZRE for real estate exposure?

  13. Hmichaluk October 17, 2014 at 1:36 pm

    Daily automated threshold rebalancing is efficient particularly if brokerage fees are absorbed, but can lead to longer term tax costs and bookkeeping labor tracking ACBs. Methinks there should be the option for time based rebalancing using the option of new money if the client prefers. I’m still suspicious of the risk analysis done by this firm. Their online risk = 1 with 25% junk bonds and another 25% corporate bond allocation with another 25% equity allocation is not a conservative low risk allocation!

  14. Canadian Couch Potato October 17, 2014 at 1:37 pm

    @Andre: I do think that exposure to small-cap stocks is important. Getting some of that through a total-market index fund is enough for most investors, but those with larger and more complex portfolios can also use a small-cap ETF to get additional exposure. There is really nothing useful on the TSX. The Canadian small-cap market is terribly undiversified, and the only US small-cap ETF uses currency hedging (not recommended). If you want to do this you really need to use US-listed ETFs. Vanguard has a few, including VB, VBR and VSS. iShares also offers them: IWM, IWN, SCZ and so on.

    @Paul: In context, all David Nugent meant was that you can find lower-cost ETFs than the ones they use, and that the DIY option is always going to be the lowest cost.

    @Paul: I have no issue with VNQI, but I think once you start using three REIT ETFs you’re making the portfolio awfully complicated. A single global REIT fund would probably make more sense, though there really aren’t a lot of great ETF options. (We use the DFA Global Real Estate Securities Fund at PWL Capital, but unfortunately this is not available to DIY investors.)

  15. Tristan October 17, 2014 at 5:32 pm

    @Paul: Another option for a larger portfolio is to split the REIT allocation between ZRE and RWO. RWO is a global real estate ETF, about half US an half international real estate. At least that will give you 2 ETFs instead of 3.

  16. Bob October 17, 2014 at 7:23 pm

    @Tristan and CCP: ZRE and RWO sounds like a good option. I hold ZRE in my TFSAs – any idea where is the best place for RWO, since this is a US-listed ETF?

  17. gsp October 17, 2014 at 11:04 pm

    @Bob, RWO and other US listed foreign REITs are best held inside RRSP due to their large foreign distributions (taxed as income even if it is ROC!)and to avoid US dividend withholding.

    As another poster above I prefer equal parts VNQ/VNQI if one insists on foreign REIT exposure.

  18. Weekend Reading - packing edition - Tawcan October 17, 2014 at 11:46 pm

    […] a 2 part interview with Wealthsimple on a new type of financial advisor. Here’s part 1 and part 2 of the interview. I think it’s very neat to see more competitive financial services in […]

  19. Kidam November 28, 2014 at 10:15 am

    Just a small question regarding that kind of service. For someone looking for a balance low maintenance option what would be the advantage of wealthsimple over lets say simply dropping it all on MAW104 or MAW105 for unregistered account.

    Bottomline they cost the same but in the case of MAW you are removing any emotionnal variable, you set it up, dump whatever you can whenever you can and let time do its thing. I’m a big advocate of simplicity and ease of use but once you ”know yourself” and have established the risk level that fits you wealthsimple has of today doesnt bring alot to the table right now. Down the road its just another Fama-French inspired allocation with a pluggin the reassess your profile on a regular basis.

    For someone going the balance road what does wealthsimple add to the table over a 20+ year track recorded that cost the same?

    Am I missing something?

  20. Canadian Couch Potato November 28, 2014 at 10:25 am

    @Kidam: I don’t think you’re missing anything: there’s nothing wrong with using a single balanced fund. The big mystery is why more people don’t use that simple solution. That said, ETF portfolios can be much more flexible: you can choose your own asset allocation, and you can hold different asset classes in different account types according to their tax-efficiency (although WealthSimple does not yet offer this).

  21. Seb Breau July 8, 2015 at 1:10 pm


    Would you say their portfolios follows a sound passive strategy, with allocations like “Purpose Tactical Hedged Equity Fund”?

    Thanks you for writing your blog, it’s very helpful.

  22. Canadian Couch Potato July 8, 2015 at 7:58 pm

    @Seb: In my opinion there is nothing passive about the Purpose “tactical” ETFs. These are active strategies.

  23. Seb July 14, 2015 at 1:01 pm

    I currently have a passive ETF portfolio that I manage with a discount broker. WealthSimple’s offerings look interesting to take me out of the equation. The more I read, the more it seems like the investors tend to be their own worst enemy.

    Would you recommend their portfolios even if they use an allocations of 5-15% to actively managed products (Might be higher if the Tactical ETFs isn’t the only one used)?

    Would you recommend a different strategy to take the investor out of the equation (I have looked around my area, but haven’t been able to find anyone that takes small clients looking to invest in low cost products)? Also, single fund ETFs and mutual funds are interesting, but I can’t gradually reduce my stock to bond allocation as I approach retirement (which is a while away). The Vanguard Target Retirement Funds in the US seem to be ideal, but they are not available here(?).

  24. Canadian Couch Potato July 14, 2015 at 7:46 pm

    @Seb: Have you looked at ShareOwner? If all you are looking for is an ETF portfolio with automatic rebalancing it is certainly the most flexible option, since you can choose your own ETFs and your own asset mix. I think the obstacle here is resisting the urge to tinker:

  25. Charles Messier September 18, 2016 at 8:55 am

    Hi Dan,

    My money is all at Wealthsimple since couple of weeks. I really like it, but I’m wondering if I could make more money If I buy ETF myself, and rebalancing it once a year, following a portfolio model like the canadian permanent portfolio of Andrew Hallam or the agressive one you suggest.

    Thank you !

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