Archive for the 'ETFs' Category

Ask Dave: All Foreign ETFs RRSP-eligible?

Published
by
Dave
1 month, 3 weeks ago
in Ask Dave, ETFs and RRSP
. 1 Comment

Charles asks:

Are all Vanguard’s ETF RRSP eligible? What about U.S. iShares or Wisdom Tree or Powershares?

Thanks for the help!

Well all US stocks are RRSP-eligible and ETFs are just stocks. I suppose the only hitch is that you have to find a broker that offers registered accounts and allows you to put US stocks in them. Fortunately, I don’t think there are any discount brokers in Canada they don’t allow you to purchase US stocks and that don’t offer registered accounts.

Be wary of Wisdom Tree and Powershares. The MER of Wisdom Tree’s ETFs are higher than Vanguard’s. I was not able to find the MER of Powershares funds within 5 minutes so they are most likely high. They sell an insane number of ETFs–also a sign that their ETFs are probably costly.

iShares has some low MER ETFs. For example, iShares S&P 500 Index Fund (IVV) has an MER of 0.08% compared with Vanguard Total Stock Market ETF (VTI) which has an MER of 0.07%. In general, Vanguard sells the lowest cost ETFs.

Popularity: 30% [?]

FFI (Fund Fee Index): Useful?

Published
by
Dave
1 month, 3 weeks ago
in ETFs, Indexes, Media and Mutual Funds
. 1 Comment

Rob Carrick recently did some analysis of mutual funds’ and ETFs’ MERs relative to their performance, which he calls FFI (Fund Fee Index) (see “How to get the skinny on your fund’s fat fees“). The FFI is supposed to be used as “a new way to measure the value you get from the fees you pay to your own mutual funds and exchange-traded funds.” It is calculated as follows:

FFI = \frac{MER}{gross\ return + MER} \times 100 = \frac{MER}{gross\ return} \times 100

Cute idea, but unfortunately it is a fairly meaningless measure since paying more expenses to a mutual fund company will not get you more gross returns (because returns are random). The big thing you will notice from the chart is that all the iShares ETFs scored far lower. In fact, as Carrick points out:

The best index score for a mutual fund was the 8.7 earned by the Phillips Hager & North Dividend Income. The worst score on the ETF side was the iShares Cdn Short Bond Index Fund at 4.8. Here, we have a vivid example of how the low fees of ETFs work to the advantage of investors. The ETF scoring worst on the Fund Fee Index beat the mutual fund with the best score.

That’s right, each of the 12 ETFs he chose beat the top 50 mutual funds of all types according to his FFI measure. He praises ETFs’ low fees, which is why the ETFs’ FFI scores are consistently lower than those of mutual funds, but stops short of making any grander conclusions. He says “it’s pointless to generalize about the value that investors get for the mutual fund fees they pay – some funds are outstanding, many are middling and some are pretty bad.” Maybe so, but we can definitely generalize and say that investors get much more “value” (I’m using Carrick’s definition of value here… a low FFI) out of ETFs than they do from mutual funds.

In general the FFI is a useless measure. Here’s an example. If a mutual fund or ETF had a 5 yr. annualized return of 1% and an MER of 0.1%, we get an FFI of 11 \left( \frac{1+0.1}{0.1}=11 \right). Let’s say another fund or ETF had a 5 yr. annualized return of 20% with an MER of 2%. That gives the same FFI of 11 \left( \frac{20+2}{2}=11 \right). So what does that tell us? That these two investments are equally “good”? The FFI hides the returns and in the end doesn’t tell us anything.

The only way in which the FFI is moderately useful is for comparing funds in the same sector or market. Then we can truly understand why the ETFs have lower FFIs than the mutual funds and what that actually means. The FFIs for the ETFs range from 0.9 to 4.8. These are ETFs such as iShares CDN Composite (XIC) with an FFI of 1.3 and the iShares CDN Short Bond Index (XSB) with an FFI of 4.8. The gross returns of the mutual funds should, on average, be equal to the gross return of the iShares ETF in the same category (because the gross return of the iShares ETF is the market average’s return). So when comparing ETFs and mutual funds in the same sector, the only variable affecting the FFI score is the MER. The higher the MER, the higher the FFI. So for this specific case, the FFI basically just becomes another measure for the net return, and as Rob Carrick says “The ETF scoring worst on the Fund Fee Index beat the mutual fund with the best score.” But what he is really saying here is that in any given sector, the iShares ETF for that sector had a higher net return than all the mutual funds in that sector that he looked at.

Popularity: 32% [?]

Sigh…Another Report Shows That Mutual Funds Don’t Beat Indexes

Published
by
Dave
4 months, 3 weeks ago
in ETFs, Indexes and Mutual Funds
. 1 Comment

John Chevreau looks at the latest “the SPIVA (Standard & Poor’s Indices Versus Active Funds) scorecard for 2007″ and it doesn’t look good. When will the average Canadian realize that investing in mutual funds is a loser’s game? Check out Andrew Teasdale’s interesting comments below the article. Here’s a snippet:

Mutual funds in general are products whose main objective is to earn returns for financial intermediaries and financial institutions and in many respects pander to the short term whims of the general investing public and the financial community at large. Sadly the mutual fund industry (as a whole) could be considered more of a game with the odds stacked against the investor than a serious attempt to deliver value and discipline. . . Canada however is one of the worst offenders when it comes to the value for money mutual funds offer the investor. When will Canadian investors as a whole start to realize that the odds, based on the current status quo, are more often than not stacked against them?

Popularity: 54% [?]

Ask Dave: What’s the Best ETF Allocation 15 Years Away from Retirement?

Published
by
Dave
5 months ago
in Ask Dave, Asset Allocation and ETFs
. 2 Comments

Our question today comes from Charles who asked me what he should do with his dad’s pension assets, which are currently invested in two mutual funds:

Hey Dave!

My name is Charles, and I am a Finance student at the John Molson School of Business in Montreal. Lately, I decided to take over my dad’s pension fund. His company provides my dad with $15,000/year to be invested with Desjardins Financial Security (I don’t think you have this Quebec bank in BC but it is popular here and in Ontario). His plan is a defined contribution plan and not a benefit plan. When I look at my dad’s assets, he had 2 funds: 1) Jarislowsky Fraser Balanced Fund 2) Jarislowsky Fraser Canadian Equity Fund — These funds are not beating the market (benchmark) often and if they do…well these funds MER are expensive so they perform worse than the market.

Therefore, I wanted to take over his asset allocations but I have no choice but to deal with Desjardins since his company deals with them but of course I or my dad can choose its asset allocations.

I am a strong believer of index funds and ETFs. Desjardins offers great Barclay’s (iShares) ETFs: 1) Active Canadian Equity fund, 2) EAFE Equity Index, 3) Universe Bond Index Fund, and 4) S&P/TSX Composite Index Fund.

My dad is currently 48yrs old and wants to take its retirement when he his 63 - 65 years old. Therefore, a good 15 years of investment.

Here’s my question…what should be my weights in each asset class?

I was thinking 70% equity; 25% bonds and 5% T-Bills. Is having all of the 25% bonds in the Universe Bond Index Fund good? As for the equities, is 60% in S&P/TSX Composite Index Fund and active Canadian Equity fund and 40% for EAFE Equity Index any good? If I have the S&P/TSX index..is Active Canadian Equity relevant?

You can find all the info for each fund on Desjardins‘ website:

Again, thanks for your help and thanks for your great website!

First of all, it’s too bad that Desjardins does not publish the MER of those funds, although it is pretty much a given that they are going to be higher than any Barclays (iShares) ETF.

Although Charles says that “these funds MER are expensive so they perform worse than the market” it seems that over the last 10 years the Jarislowsky Fraser Canadian Equity Fund has outperformed the S&P Composite Index (16.3% to 9.5%). Although that probably says more about your dad’s reasons for choosing this fund over the others and this fund’s longevity, than it does about the fund’s prospects of “beating the index.”

Currently Charles’ dad is invested in 77.5% equities (50% from JF Canadian Equity Fund and 27.5% from JF Canadian Balanced Fund) assuming that he is invested equally in both of these two funds. My first recommendation would be not to deviate too much from what his dad was invested in before. This isn’t Charles’ portfolio, and if things turn ugly (or uglier?) for either stocks or bonds he doesn’t want to be the one to blame for shifting him more or less into either category. So I don’t see anything wrong with going with 70% equities in his new ETF based portfolio. I really don’t have a precise answer on what allocation of bonds/equities is right for your dad. I would try to stick with a balanced approach, and by that I mean that he should be invested 25-75% in equities and 25-75% in bonds (neither all bonds or all stocks). Risk assessments on banks’ websites (like TD Canada Trust’s Retirement Strategy Tool) are somewhat useful, not to come up with a precise answer, but to give you something that is in the ballpark. If anything, psychologically they can give Charles and his dad some comfort.

The Bond Universe fund is a good way to capture the bond market.

I don’t see anything wrong with his allocations within the equity class. I would not bother with the Active Canadian Equity as he will just get poorer performance (on average) than the index itself (after MERs). The only other thing that I noticed is that there is no exposure to the US market here as it looks like Desjardins does not offer Barclays’ (iShares) S&P 500 Index. I assume his dad has other investments besides this pension? If so, then I hope Charles will look at his entire portfolio (pension + RRSP + spouse?) as one, rather than each individually and hold a US index outside of his pension.

Popularity: 59% [?]

Ask Dave: US Dollar ETFs

Published
by
Dave
5 months, 2 weeks ago
in Ask Dave, ETFs and Economics
. 0 Comments

Another question (or should I say several questions) from a reader about US dollar ETFs. Paul wrote:

Thanks for the great blog - as a relatively new investor interested in building an ETF portfolio, I have found a great deal of useful information on your site - its much appreciated. I wanted to ask you a few questions regarding the use of the Vanguard ETF’s especially in light of the soaring loonie which is nudging US$1.06 these days.

Do you think that the strong loonie should be an extra incentive for Canadians to buy the Vanguard ETF’s to diversify their portfolios? I feel that the strong loonie offers us an opportunity to buy these US$ based shares at a discount given that historically the CAD has been weaker than the US$. But I have read some blogs that warn that that may all be changing and that with increasing global demand for Canadian resources and with the problems in the US economy, we may see our dollar at least on a par with the US$ for a while to come.

No, I don’t think that the fact that the Loonie is extra strong (relative to the past) should be any extra incentive to buy Vanguard ETFs (read: US dollar ETFs). You are right, with pending problems in the US economy and increasing demand for Canadian resources the Canadian dollar may go even higher, or the Canadian dollar may fall back (or the US dollar may rise) to it’s historical norm relative to the US dollar. It is difficult to predict. It is good to own Canadian dollars if you plan on spending the proceeds of you investments in Canada. On the other hand if inflation ever became very bad in Canada and the Canadian dollar fell against the US dollar it would be nice to have US dollars. Also, if the Canadian dollar fell against all other currencies and you planned to spend your retirement savings travelling, then it would be nice if some of those investments were in something other than Canadian dollars. I think it’s important to have a balance and to not put all your eggs into one basket. He continued,

Also, I read your post about the exchange rate spread issue when buying US based ETFs and how if you do not plan to keep these ETF’s for a long time, the MER is essentially boosted by the costs associated with converting CAD to US$ and then eventually back again. Would this issue not lend more argument to buying ETF’s like XIN or XSP which have higher MER’s but at least you do not have to pay a chunk of change when you convert back to CAD?

Of course you would have to do some calculations yourself to see which is better (or see my post about foreign exchange costs). There are a bunch of variables involved: the foreign exchange rate spread, the MERs of XIN/XSP, the MERs of the Vanguard US$ equivalents, and the length of the time the investments were held. In general you’ll probably see that as the length of time increases, the lower MER investment will become more attractive. As the length of time decreases, the investment without the foreign exchange fees will become more attractive.

Lastly, I have read a lot about the exchange rate risk Canadians face buying ETF’s like VWO, VEA, VPL or VGK. How much of an issue is this? Surely as long as the ETF grows and we are buying these ETF’s now with a strong loonie, the risk must be fairly small and one could do well when the CAD eventually returns to a more realistic level with the US$.

I try not to worry about it too much because if you look at the long term historical trend, the Canadian dollar and the US dollar have not diverged substantially, although they do encounter some pretty big swings, as we have recently witnessed.

Right now I am inclined to overweight my portfolio with VTI, VWO, VPL and VGK to take advantage of the buying power of the loonie and then rebalance it with more XIC later when the CAD weakens a bit. Would this make sense right now or is there serious risk to assuming the CAD will weaken in the next few years?

Personally I wouldn’t assume the CAD will rise of fall in the next few years. Plan for a probability of either situation happening. Stick with an allocation of CAD and an allocation of USD that you are comfortable with, no matter what the current state of the loonie/dollar is, and the stick to that allocation. If you want to speculat, that’s up to you, however, but if you’re talking about a retirement portfolio I would just pick an allocation and go with it. If one currency rises substantially above the other you’ll find yourself buying the cheaper currency just to keep the portfolio balanced.

Anyway, thanks for you help and I look forward to reading your thoughts on these issues.

Thanks for your question Paul, and sorry for the delay in responding to it.

Popularity: 59% [?]

The Real 10 Commandments of Investing

Published
by
Dave
8 months, 2 weeks ago
in Asset Allocation, Bonds/Fixed Income, Costs, ETFs, Gurus, Indexes, Investing, Mutual Funds and Stocks
. 5 Comments

Rob Carrick recently “gathered 10 of our favourite bits of investing advice, on topics ranging from stock-market risk to which mutual funds to buy” and called it the 10 Commandments. A commandment is “a command or order,” so something like “thou shalt not use the word commandment incorrectly” is a commandment. “Commandment” #10 is “Investors repeatedly jump ship on a good strategy just because it hasn’t worked so well lately, and almost invariably, abandon it at precisely the wrong time.” C’mon that’s not even a commandment! So what is the order here, that we should not jump ship on a good strategy that goes bad? or should we not use strategies? or should we abandon them at precisely the right time instead of the wrong time? The longer explanation does not leave things any more clearer, offering such advice as “ignore the slumps or use them as a buy-low opportunity,” or ” judge whether your fund manager has what Dreman calls a good strategy.” For what’s it’s worth, the only words of advice in there I thought were useful were Buffett’s (use low-cost indexes) and Malkiel’s (less fees are better).

A while ago a guy named Alan Haft (he wrote a book called “You can never be too rich”) made up his own 10 Commandments of Investing and it’s been in my drafts folder ever since I saw it. I think he sums up the most important things that people should do with regards to investing, they are well written, and they make sense. Here they are:

  1. Stick with the indexes
  2. Watch those fees
  3. Create a bond ladder
  4. Diversify
  5. Watch your money
  6. Don’t rush in
  7. Don’t take the risk if you don’t need the return
  8. Get out if something isn’t working
  9. Understand tax consequences
  10. Keep it simple

Here are some highlights:

1. Stick with the indexes
Leave the individual stock picking to gamblers and speculators. Very few people really understand how to successfully pick individual stocks, and if they do, the news that drives markets today is totally unpredictable, making individual stock picking a highly risky venture. Reams and reams of statistics prove index investing almost always outperforms the financial advisors, money managers, and stockbrokers. Stick with the indicies and you’ll likely wind up far ahead of the game. Care to speculate a bit on some individual stocks? Do it with a small portion of your money, but certainly not the bulk of it.

2. Watch those fees
Wall Street loves investors that don’t watch their fees. For those investing in funds, check out www.personalfund.com. You might be shocked to find out the total cost your funds are charging you to own them year after year. Especially over the long haul, fees can destroy your returns. Minimize fees as much as possible by investing in low-fee, highly diversified investments such as one of my personal favorites, Exchange-traded funds such as those offered by www.ishares.com

7. Don’t take the risk if you don’t need the return
Many people would do perfectly fine getting 7-10% returns on their money, yet their portfolios are invested in things that strive for well beyond that. Especially if you’re a retiree, if you doubled or tripled your money overnight, would you go out and buy a fancy new sports car? A mansion on the hill? Few of us would. And for that reason, always ebb towards the safer side of investing as much as you possibly can

Check out the original article for the rest!

Popularity: 95% [?]

Indexes Have the Advantage in Bear and Bull Markets

Published
by
Dave
8 months, 2 weeks ago
in ETFs and Indexes
. 10 Comments

There was yet another Rob Carrick disaster in the Globe & Mail this week, a newspaper that I am losing respect for all the time. After reading the headline,
ETF advantage fades in down market, I knew it was going to be a beauty. He starts off by explaining that index funds and ETFs “clean up” in a bull market.

One of the top no-brainer investing moves is to put money in an exchange-traded fund or index fund if you want to clean up in a bull market.

But why just in a bull market? It is unfortunate that he doesn’t give any reason why indexes might perform better in a bull market (or bear market). The most obvious reason is that index funds or exchange-traded funds represent “the average” but have lower MERs. This same logic should apply to bear markets right? His whole argument that ETFs and index funds “beat” actively managed mutual funds in bull markets but perform poorly in bear market is weak. It rests completely on being selective about what past periods to look at and a belief that mutual fund managers are “market pros [that] are using their training and experience to pick the best stocks.” Couple that with reporters’ tendencies to write about both sides of the story, in this case searching for advantages and disadvantages to both index ETFs and mutual funds even if it means leaving readers with an unfair and inaccurate picture.

In the second paragraph, he mentions that ETFs did not perform that well between Sep. 1, 2000 and Oct. 31, 2007 but from 2002 onward they performed much better than actively managed mutual funds. He thinks he has it all figured out; index ETFs perform poorly in a period that includes a bear market.

. . . the advantage of ETFs isn’t so clear over a longer period that includes a down market. The past seven years are a good example. If you bought ETFs at the peak of the last bull market on Sept. 1, 2000, and held until this past Oct. 31, your returns would look puny compared with many popular Canadian equity mutual funds.

He even suggests that investors consider “investing in the Canadian market, but through mutual funds rather than ETFs” because “the S&P/TSX composite is looking shaky right now after a five-year bull run.”

He describes accurately how the S&P TSX Large Cap index did poorly after Sep. 2000 and explains one of the reasons for this: the fact that Nortel made up close to one third of the index whereas mutual funds were limited to about 10% exposure for each stock. So when Nortel lost almost all of its value after 2000, the index, with more Nortel exposure, would have faired much worse than actively managed mutual funds (in fact, the index performed so badly that the “capped” S&P/TSX 60 index was created after the Nortel debacle). The index would have also faired much better than the actively managed funds between 1997 and 2000 because of Nortel’s gains thus compensating for the loss from 2000-2002; however, he conveniently leaves out the 10-year figures (1997-2997) and only uses a “seven-year comparison prepared especially for this Portfolio Strategy column.” His reason for not using 10-year data is that “a 10-year slice is of little use because many funds and ETFs haven’t been around that long.” I find that rather odd because the TSE/S&P TSX Composite has been around since 1977 and the TD Canadian Index mutual fund have been around for 10 years! Of course I agree that “many funds and ETFs haven’t been around that long,” but since we’re only looking at Canadian equities here, isn’t one Canadian index enough? After all, he only looked at one index for the 7-year period.

I decided to get my own figures from Morningstar’s Fund Selector:

  Number of funds that beat the TD Canadian Index Fund Total number of Canadian Equity funds % of funds that performed worse than the TD Canadian Index Fund
3 yr. 90 279 68%
5 yr. 25 218 89%
10 yr. 23 68 66%

My Method: Using Morningstar’s Fund Selector I searched for funds in the “Canadian Equity” category that have a 10-year return greater than -50%. This allowed to me to find out how many funds have been around for the past 10 years. Then I searched for funds that had performed better than the TD Canadian Index fund over that same 10 year period to determine how many funds beat this index fund. I then repeated the same procedure for 5 yr. and 3 yr. periods. The TD Canadian Index fund’s performance over the 3, 5, and 10 years periods was 19.8%, 20%, and 9.2% annualized, respectively.

As you can see from the table, the indexes beat a large percentage of actively managed mutual funds over the past 3, 5, and 10 year periods. Note also that there is some survivorship bias in these figures. Presumably, in 1997 there were more than 68 mutual funds in the “Canadian Equity” category but only 68 “survived” until 2007. One can assume that the ones that did not survive were more likely to have performed worse than the index, hence their reason for being discontinued, retired, or merged with other funds. So the percentage of funds that performed worse than the TD Canadian Index Fund is likely to be higher than 66% if we could somehow include funds that existed in 1997 but no longer exist in 2007.

Indexes can do even better than this if only the MER was lower. The TD Canadian Index fund has an MER of 0.85% but the iShares CDN S&P/TSX Cap Composite Index (XIC) has an MER of 0.25%. XIC does go back 5 years; however, it wasn’t always tracking the TSX Composite; it used to track the TSX/S&P LargeCap 60 index so I will not look at its performance values. Let’s assume that if XIC (in it’s present form) had existed 10 years ago, it would have performed 0.6% better than the TD Canadian Index Fund over that same period due to its lower MER, or 20.4%, 20.6%, and 9.8% annualized over the past 3, 5, and 10 year periods, respectively. This approximation is consistent with the fact that in 2006 the TD index returned 16.4% but XIC returned 17.0%, a difference of exactly 0.6%. I re-ran my fund searches on Morningstar and here is what the performance would be if XIC existed 10 years ago in its present form with an MER of 0.25%:

  Number of funds that beat the hypothetical iShares CDN S&P/TSX Cap Composite Index (XIC) Total number of Canadian Equity funds % of funds that performed worse than the hypothetical iShares CDN S&P/TSX Cap Composite Index (XIC)
3 yr. 63 279 77%
5 yr. 14 218 94%
10 yr. 20 68 71%

As we see once again, the S&P/TSX Composite Index with a 0.25% MER has outperformed over 71% of all actively managed mutual funds in the “Canadian Equity” category in the last 10 year, 5 year, and 3 year periods ending in Oct. 31, 2007. I have not cherry-picked any period and I have shown three different periods, not just one. I have not thrown out any periods based on whether or not they include or don’t include either bull markets or bear markets. The original article only looks at one bear market and concludes that indexes perform worse than active management in bear markets. I am not at all convinced that this is a consistent truth or “rule.” There is lots of data from the US for example that shows that over long periods of time (which include more than just one bear market) indexes handily beat actively managed mutual funds. In A Random Walk Down Wall Street, Burton Malkiel quotes a Lipper study (2007 edition, pages 267-268) that found that from Dec. 31, 1985 to Dec. 31, 2005, the S&P 500 index beat 82% of mutual funds and on average performed 1.5% better than the average fund per year. I would find it very hard to believe that one could increase performance even more by switching from indexes to mutual funds at certain times, or even holding some balance of mutual funds and indexes. Even if we looked at more than one bear market and it turned out that indexes did perform worse in every bear market, without being able to predict when future bear markets start and end, would this information be helpful? How would you know when to switch to mutual funds and then back into index ETFs for the next bull market? You would be guessing and in the end you would lose out due to commissions spent on buying and selling the ETFs and the higher MERs on mutual funds.

Popularity: 65% [?]

Ask Dave: Index ETFs and Rebalancing (or lack therof)

Published
by
Dave
9 months, 1 week ago
in Ask Dave, Asset Allocation, Costs, ETFs and Indexes
. 4 Comments

I while ago I bought Vanguard Europe Pacific ETF (VEA) for the international portion of my portfolio and one reader had the following comment:

Just a quick question. With regards to balancing one’s portfolio, would ETFs like VEA (and I see there is now one that encompasses the whole world excluding the US), not pose a problem? If for example the European markets did well one year but the Pacific markets performed poorly, then one would be unable to rebalance by selling a European based ETF’s (like VGK for example) and buying more Pacific based ETF’s (VPL for example). With everything in one basket one could not take advantage of the gains to be made by selling high and buying low. Is this assumption correct? Or is it true that because VEA comprises 75% VGK and 25% VPL, that it would reflect any net changes made by owning a combination of both VGK and VPL?

Your assumption is correct, one could not take advantage of the gains to be made by selling high and buying low the stocks in one region vs. another. These rebalancing “bonuses” are small, but more importantly, they may completely disappear after trading costs are taken into account. VEA does not contain a fixed percentage of VGK and VPL underneath. It contains the market cap weighting of all its components. Market cap-weighted indexes have several advantages as investments:

Market value-weighted indexes have lower trading costs. If you made your own index, and the index never added or removed stocks the stocks would be bought once and never sold. As one stock goes up in value, it maintains the desired allocation in the index. This keeps trading costs low as one essentially rarely needs to make trades, except for when stocks are dropped or added from the index. Market value-weighted indexes have the lowest MERs, and other indexes like fundamental-weighted indexes, or fixed-weight indexes have higher MERs due to increased trading within the index.

With market value-weighted indexes, one never ends up holding on to dogs. Imagine it is the early 1900s and you own shares in a fixed sector-weighted index (did such a thing exist back then?). The index contains 25% financials, 25% railways, 25% consumer goods, and 25% manufacturing (or a fixed percentage of each individual stock, it’s the same thing). Every year the index is rebalanced. Pretty soon railways start to go out of style as air travel is invented and highways are built. The 1960s arrive and “tech” stocks are all the rage. The index rebalances religiously, which leads it to purchase a lot of railway stock which continues to do badly, meanwhile it has missed out on the rise in tech stocks. The worse railways do, the more you have to buy in order to keep your portfolio balanced (in addition to paying more commissions). You now wish the index had altered their weightings to contain less railways. One way to do it might have been to not fix the amount allocated to each sector and just use market cap-weighting instead. Or use market cap-weighting while taking into account large changes in what is going on in the market. For example, one could have envisioned a “smarter” version of the S&P 500 index that underweighted tech/IT stocks in around 2000 (selling high) and went back to their appropriate market cap-weight in 2002. Of course we only wish we had a crystal ball back in 2000 that could have warned us that tech stocks were about to fall. It seemed inevitable, just as it did in 1997. Unfortunately there is no foresight in the market and there was no telling if tech stocks would not have kept climbing after 2000. Furthermore, if you believe that markets are largely efficient, there is no such thing as “buying low” or “buying high” and it is not possible to “take advantage of the gains to be made by selling high and buying low” as there are essentially no “gains” to be made. There are only “losses” to be incurred through increased costs of trading and higher turnover.

In the scenario you described you said “If for example the European markets did well one year but the Pacific markets performed poorly, then one would be unable to rebalance by selling a European based ETF’s (like VGK for example) and buying more Pacific based ETF’s (VPL for example).” Personally I would get a bit nervous in buying more VPL. How do you know it is at a “low”. What if it actually at a “high” of even greater future “lows.” I was in an investment club from around 1999-2005 (the club ended in 2005). We consistently thought we were buying stocks at “lows.” We bought stocks like Nortel, Nokia, 360 Networks, Global Crossing, Lucent, etc… after sharp declines only to watch them decline even further (often with another purchase on the way down for good measure). So this is the problem I have with fixed allocations and rebalancing. If you bought 75% VPL and 25% VGK and held them in your portfolio. How do you know if 25% VGK is “just right”, “over-valued”, or “under-valued.” If it falls to 15% now how would you classify it? If it was over-valued before, now it might be just right. If it was just right before it might be considered under-valued now. But if it were truly under-valued (in the sense that the equities in VGK are worth far more than what the market is valuing them at) most likely other smart investors would have already taken advantage of it (as if you’d be the first to realize it!) and so it’s most likely that those equities are “just right.”

I blogged a lot about Equal Weight Indexes in the past:

  • In Non-Market Cap Weighted Indexes: The Next Big Thing I ballyhooed equal-weighted indexes and lamented the lack of equal-weighted indexes in Canada. My opinion of equal-weighted indexes would soon change.
  • In Equal-Weight S&P 500 Index I came to the full realization that RSP, the S&P 500 Equal Weighted index only performed better because of its higher concentration of mid-cap stocks.
  • In Too Many Choices (or why I am ready to give up) I mentioned that “I have now come to the realization that RSP is very similar to the S&P 400 Midcap Index which is also available as an ETF (MDY). It is very highly correlated . . .”

Regrettably, I don’t think equal weight indexes are all that I initially hyped them to be. I did some searching on the web for more information on the advantages of market cap-based indexes over fixed weight indexes but had trouble finding any information at all, however, I think my reasoning above makes sense. As in many arguments over financial instruments and investing strategies, cost is again a huge factor.

Popularity: 66% [?]

Fidelity Says You Need 80% Pre-Retirement Income in Retirement (just don’t use them to get you there)

Published
by
Dave
9 months, 2 weeks ago
in Advisors/Brokers, Calculations, Costs, ETFs, Indexes and Mutual Funds
. 5 Comments

According to Fidelity, we need 80% of our current income to retire (see Canadian Capitalist’s “Fidelity’s ‘Scary’ Retirement Findings“, where I found this story). Canadians on average have 50% of their pre-retirement income in retirement, but this is no different from other countries; United States: 58%, Britain: 50%, Germany; 56%, Japan: 47% (see “Want to play in retirement? Test your future income“). If those numbers are not adequate, it implies that the average senior in the United States, Britain, Germany, and Japan are all in dire need. I doubt that is the case. (My opinion is that people should save as much as they want. You might need only 50% but if you want to spend a lot in retirement and travel instead of just tinkering in your garden then maybe you need 80% of your pre-retirement income, or maybe 150%, just in case.)

The funny part is that even if you wanted to get to 80%, the hardest way to get there would be to use Fidelity’s products. All their MERs are above 2% (click on Facts & codes). It’s too bad their retirement calculator doesn’t have a slider bar for the MER or rate of return, then you would be able to see just how badly these management expense fees can affect the final value of your portfolio, and in turn, your annual income in retirement.

I just did a calculation and if you invest $8,500 annually starting from the age of 30 you end up with $2 million at the age of 65 if the contributions are indexed to inflation and the rate of return is 8% (the return you might get if you buy a low-MER (0.25%) investment, like an index ETF). Decrease that return to 5.75% (the return you’ll get if you pay a 2.5% MER on Fidelity mutual funds or their managed portfolios) and you’ll have only $1.32 million at age 65. Assuming $2.64 million is what one would need to keep the same income one enjoyed pre-retirement:

In the 2.5% MER case: $1.32 million is 50% of $2.64 million

In the 0.25% MER case: $2 million is 76% of $2.64 million.

So by simply not using a company like Fidelity and going with a competitor like Vanguard or iShares and buying index ETFs (with far lower MERs) instead, you can easily get closer to that 80% figure and increase your nest egg from to $2 million from $1.32 million without even having to save any more money. By the same token, it could probably be argued that one of the main reasons that Canadians do not have 70-80% of their pre-retirement income in retirement (and only have 50% instead) is because of the amount of MERs, fees, and commissions they pay every year to the financial industry.

See also:
Should Retirement Replacement Ratio be 50%, 80% or in between?

Popularity: 74% [?]

The Average Actively Managed Fund Must Underperform the Index

Published
by
Dave
9 months, 3 weeks ago
in ETFs, Indexes and Mutual Funds
. 8 Comments

In last Saturday’s Globe & Mail (finally got around to reading the paper today), Rob Carrick compared the performance of Canadian equity funds to a low-cost index ETF that covers the entire Canadian market, iShares CDN Composite Index Fund ETF (XIC). It is the one I own to capture the Canadian market and it makes up the entire Candian equity portion of my portfolio. He went five years back because the ETF has not been around for 10-years yet. He compared this ETF to the “100 or so funds in the Canadian equity category that have been around for the five years to Sept. 30.” Surprise, surprise, only 5 mutual funds beat the index over that period. Here are some of those funds, sorted by 5-yr % return:

Fund name MER 5-yr % return 5-yr beta
Acuity All Cap 30 Canadian Equity 2.85 27.96 1.385346
imaxx Canadian Equity Growth 2.76 24.54 0.986167
Altafund Investment Corp. 2.72 22.02 1.042311
TD Canadian Equity 2.09 21.39 1.145336
iShares CDN LargeCap 60 Index 0.15 21.39 0.980728
TD Canadian Equity-A 2.09 21.09 1.130500
iShares CDN Composite Index 0.25 20.94 1.002607
Desjardins Environment 2.35 20.71 0.985526
OTG Diversified 1.30 20.51 0.981718
Altamira Precision Cdn Index 0.53 20.45 0.983078
iShares CDN MidCap Index 0.55 20.45 0.983592
Hartford Canadian Stock D 1.88 20.43 0.949451
Integra Canadian Value Growth 2.24 20.04 0.906116
TD Canadian Index - e 0.31 19.93 0.987276
National Bank Canadian Index 1.14 19.84 0.983619
Leith Wheeler Canadian Equity B 1.50 19.72 0.720842
Ferique Equity 0.66 19.58 0.964336
Manulife Sector Rotation Fund 2.69 19.55 1.012749
RBC Canadian Index 0.71 19.55 0.996493
GGOF Canadian Lrg Cap Equ Mutual 2.39 19.54 0.878637
Hartford Canadian Stock B 2.60 19.53 0.952128
Acuity Social Values Canadian Equ 2.85 19.52 1.178193
Sceptre Canadian Equity - A 1.69 19.42 0.939199
TD Canadian Index 0.85 19.41 0.997669
FMOQ Canadian Equity 0.95 19.34 0.933744
CIBC Canadian Index 0.97 19.30 0.995622
Scotia Canadian Stock Index 1.03 19.20 0.997593
BMO Equity Index 1.01 19.12 0.994472
PH&N Canadian Equity-A 1.13 19.09 0.870502
Fidelity Cdn Disciplined Equity-B 2.24 18.98 1.019771
Fidelity Cdn Disciplined Equity-A 2.45 18.85 1.021164
Meritas Jantzi Social Index 1.94 18.81 0.872850
PH&N Community Values Cdn Equ-A 1.39 18.65 0.815829
Fidelity Cdn Disciplined Equ Cl-B 2.30 18.65 1.019219
Fidelity Cdn Disciplined Equ Class 2.50 18.52 1.020240
Manulife Canadian Equity Fund - A 2.23 18.38 1.046150
OTG Growth 1.30 18.37 0.933543
Supposedly
60+ more funds to go on this list…

Note that some funds that started 5 years ago probably got canned due to poor results (or other reasons) and are thus excluded from the “100 or so equity funds” that Carrick mentions. See Survivorship Bias.

These results should come as no shock to anyone. If it does surprise/shock you, I recommend reading A Random Walk Down Wall Street as Burton Malkiel explains the reasons why index funds do much better far better than I can. You don’t even have to believe in efficient-market theory. According to Malkiel (and others of course):

But even if markets were not efficient, indexing would still be a very useful investment strategy. Since all the stocks in the market must be owned by someone, it follows that all the investors in the market will earn, on average, the market return. The index fund achieves the market return with minimal expenses. The average actively managed fund incurs an expense ratio of about 1.5 percent per year [ed: in Canada I think this is higher]. Thus the average actively managed fund must underperform the market as a whole by the amount of the expenses that are deducted from the gross return achieved.

The only way mutual funds will do you any good is if you can predict beforehand which mutual funds will be one of the handful that do outperform the indexes (good luck). He goes on mention that this claim is actually borne out in the data from the US market in the past 20 or so years,

Between 1974 and 2006, for example, the S&P 500 outperformed more than three-quarters of the public equity mutual funds–the average annual total return for the S&P 500 was more than 1.5 percentage points better than that of the media fund

Again survivorship bias plays a role here. If we included some of the funds that existed in 1974 but did not make it to 2006, the S&P 500 would most likely have outperformed an even larger fraction of the public equity mutual funds from 1974 to 2006.

Popularity: 65% [?]

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