In my last post, I reviewed RBC’s forthcoming lineup of traditional ETFs, which will appear later this summer. The launch of these ETFs will also spark some changes in RBC’s index mutual funds: they’ll be getting new benchmark indexes and lower fees, and in some cases they’ll use the new ETFs as their underlying holdings. It’s good news for investors who want to use index mutual funds rather than ETFs, so let’s take a closer look.

We’ll start with the two equity funds that will see only a new benchmark, with no change to their structure.

The RBC Canadian Index Fund (RBF556) currently tracks the S&P/TSX Composite Index, but as of September it will be pegged to the FTSE Canada All Cap Domestic Index. (You can find the factsheets for all of FTSE’s indexes here.) These two indexes are very similar, so this is not a terribly meaningful change. The FTSE index is the same one tracked by the soon-to-be-launched RBC Canadian Equity Index ETF (RCAN), but the mutual fund will not use this ETF as its underlying holding—at least not yet.

Here’s why: the mutual fund has built up large unrealized capital gains (equal to about 24% of the fund’s net asset value as of May 19), so selling the stocks and replacing them with ETF units would mean realizing these gains and passing them along to the fund’s investors. To spare unitholders this tax bill, RBC has decided to hold off on the transition indefinitely.

The RBC U.S. Index Fund (RBF557) will be affected in a similar way: it will change its benchmark from the S&P 500 to the FTSE USA Index, the same one used by its corresponding new ETF. But because of the large unrealized gains in the fund, there are currently no plans to transition to use the new ETF as its underlying holding.

Over the hedge

The two currency-hedged equity funds in RBC’s lineup will not only see their indexes changed, but they’ll also change their structure entirely.

The RBC U.S. Index Currency Neutral Fund (RBF558) and the RBC International Index Currency Neutral Fund (RBF559) are unusual in that they don’t actually hold any stocks directly: instead, they get their exposure using index futures. This strategy is a holdover from the days when Canadians were limited in the amount of foreign investments they could hold in RRSPs. Since futures are not considered foreign investments, using them to get exposure to US an international stocks was a way of getting around that rule, which was finally scrapped in 2005.

As of September, these two mutual funds will stop using futures and instead use the corresponding new ETFs as their underling holdings: the RBC U.S. Equity Index ETF (RUSA) and the RBC International Equity Index ETF (RINT). Neither of these ETFs uses currency hedging, however, so the mutual funds will add that separately. Unfortunately, there will be no unhedged mutual fund option for international equities.

If you happen to hold either of these funds in a taxable account today, this is good news. Index futures are notoriously tax-inefficient, because any increase in their value is taxable as income rather than as capital gains. Going forward, fund investors will be able to enjoy the same tax-efficiency as ETF investors.

Strike up the bonds

Finally, here’s how RBC’s lineup of bond mutual funds will evolve.

The most significant change is the creation of the RBC Canadian Bond Index Fund (RBF700). This is a rebranding of what used to be the RBC Advisor Canadian Bond Fund, which was essentially a closet index fund. In advance of the launch of the RBC Canadian Bond Index ETF (RCUB), the mutual fund changed its name and its mandate on June 30. Starting in September it will use the new ETF as its underlying holding.

The RBC Canadian Government Bond Index Fund (RBF563) won’t change at all, except to lower its fee slightly. The fund will continue to track the FTSE TMX Canada Federal Bond Index, which, as the name suggests includes only federal government bonds. This makes it quite different from broad-market bond index funds—including RBF700—which also include provincial, municipal and agency bonds, as well as 20% to 40% corporate bonds. Holding all federal bonds is slightly less risky, but also brings a significantly lower yield.

Best of the rest

For the last few years, Option 2 of my model portfolios—for investors who use individual index mutual funds, as opposed to ETFs or a single-fund solution—has included only the TD e-Series. These are much cheaper than any other option, but unfortunately they’re available only to clients of TD Mutual Funds and TD Direct Investing. If you use any other brokerage, the choices foe index mutual funds are pretty poor. These recent changes to the RBC lineup improves the situation, though only modestly.

RBC has announced that all of their index funds will see fee reductions effective immediately. Here’s a summary of the changes to the Series A version of the funds, which are ones available to retail investors through any online brokerage:

You’ve probably noticed the fee reductions are quite minor: an investor with a $50,000 portfolio of RBC equity index funds would pay roughly $50 less in annual fees. (The newly branded RBC Canadian Bond Index Fund seems particularly expensive at 0.76% in an era when the yield to maturity is only about 2%.) The fee reductions are much greater for the Series F versions, but these are available only through fee-based advisors.

That said, for those who do not have access to the TD e-Series funds, RBC’s new lineup appears to be the next best option thanks to these lower fees, improved tax efficiency, and broader indexes. A traditional balanced portfolio built from these new funds would look like this: