MoneySense » Canadian Capitalist

New currency unhedged ETFs from iShares

Canadian Capitalist — Tue, 16 Apr 2013 14:35:17 +0000

ETF investors have long clamoured for Currency unhedged funds traded on the TSX for reasons outlined here, here and here. While it is true that Canadian investors can get direct access to foreign stocks through a long list of ETFs that trade in the US exchanges, these funds have one drawback that cannot be overcome — US-listed ETFs are considered in situ property and could be subject to US Estate Taxes. Granted, US Estate Taxes have become less problematic for most Canadian investors since the passing of last-minute legislation to avert the fiscal cliff. Essentially, Canadians with less than $5 million (US) in total assets will be able to avoid US Estate taxes entirely.

Still, Canadian-listed ETFs that do not hedge currency will be valuable for investors who do not want to look for cheaper methods of converting Canadian dollars into US dollars and who do not want to pay the usurious foreign exchange fees charged by most discount brokers. Last year, Vanguard Canada introduced the S&P 500 Index ETF (TSX: VFV, MER 0.18 percent), a fund that tracks the S&P 500 index. Now, iShares has launched three new ETFs that started trading on the TSX yesterday. They are:

iShares S&P 500 Index ETF (XUS): Track the S&P 500 index, a market-cap weighted index of 500 large US corporations. MER is 0.14 percent. Note that the ETF is essentially a wrapper around the iShares Core S&P 500 ETF (IVV) that trades on the NYSE Arca exchange.

iShares MSCI EAFE Index ETF (XEF): Track the MSCI EAFE index, a market-cap weighted index that tracks stocks from Europe, Australasia and the Far East (essentially an index of developed market stock markets excluding the US and Canada). MER is 0.30 percent. The ETF is a wrapper around the iShares Core MSCI EAFE ETF (IEFA).

iShares MSCI Emerging Markets ETF (XEC): Track the MSCI Emerging Markets Index, a market-cap weighted index that tracks stock market performance of emerging markets. MER is 0.35 percent. The ETF is a wrapper around the iShares Core MSCI Emerging Markets ETF (IEMG).

Take-away for Investors

These ETFs are great news for Canadian investors wanting Developed Markets ex North America and Emerging Markets exposure from securities listed in Canada but do not want currency hedging because the new ETFs are far cheaper than existing alternatives.
Investors should keep in mind that owning a Canadian-listed ETF that holds foreign securities in their RRSPs means incurring a 15 percent withholding tax hit on dividends. i.e. an investor who holds $1,000 worth of XUS in a RRSP will incur a tax hit of $3 per year compared to holding $1,000 worth of IVV. Note that the withholding tax hit is only for RRSPs and RRIFs.

Related Reading:

New Currency Unhedged ETFs from iShares is brought to you by Canadian Capitalist — Helping you to invest & prosper.

Budget 2013 clamps down on advantaged ETFs

Canadian Capitalist — Tue, 09 Apr 2013 12:04:10 +0000

Advantaged ETFs refers to exchange-traded products that use derivatives such as forward agreements to transform one form of distributions (often interest income) into another (such as capital gains or return of capital) that is lightly, if at all, taxed. For example, an investor holding the iShares Advantaged Canadian Bond Index Fund (TSX: CAB) in a taxable account will have received capital gains and return of capital equal to the income generated from a portfolio of Canadian Government and corporate bonds (less fees and expenses). Capital gains are taxed at half the marginal rate. If the investor had instead directly held the portfolio of bonds, the interest income would have been taxed at the investor’s marginal rate.

Budget 2013 proposes to put a kibosh on what it calls “character conversion transactions” such as the ones employed by Advantaged ETFs.

Character conversion transactions link a derivative investment with the purchase or sale of an otherwise unrelated capital property to form a derivative forward agreement. If the derivative investment were made separately from the purchase or sale of the capital property (i.e., as a cash-settled derivative financial instrument), any income from the derivative investment would be taxed as ordinary income.

To ensure the appropriate tax treatment of the derivative-based return on a derivative forward agreement, Budget 2013 proposes to treat this return as being distinct from the disposition of a capital property that is purchased or sold under the derivative forward agreement. This measure will apply to derivative forward agreements that have a duration of more than 180 days. Whether a particular property is held on income or capital account is largely a factual determination and is unaffected by this measure.

ETFs Affected by the Change

iShares Canada put out a press release saying that seven funds in its ETF line up will be impacted by the changes proposed in the Budget. It is interesting to note that all these ETFs used to be traded under the Claymore brand name. They are:

iShares Advantaged Canadian Bond Index ETF (CAB)
iShares Advantaged Convertible Bond Index ETF (CVD)
iShares Advantaged U.S. High Yield Bond ETF (CHB)
iShares Advantaged Short Duration High Income ETF (CSD, CSD.U)
iShares Global Monthly Advantaged Dividend Index ETF (CYH)
iShares Broad Commodity Index ETF (CBR)
iShares Managed Futures Index ETF (CMF, CMF.A)

ETFs Not Affected by the Change

Horizons also put out a news release saying that the Budget proposals are not expected to impact the popular Horizons S&P/TSX 60 Index ETF (HXT) because the ETF makes no distributions and hence there is no re-characterization taking place. Horizons confirmed that the Horizons S&P 500 Index ETF (HXS) is also not expected to be affected by the move. Nevertheless, investors should weigh the risk of an adverse change in tax treatment of swap-based ETFs against the tax advantage of earning total returns.

See also: Canadian Financial DIY’s and Canadian Couch Potato’s takes on this topic.

Related Reading:

Budget 2013 clamps down on Advantaged ETFs is brought to you by Canadian Capitalist — Helping you to invest & prosper.

This and That: Grantham interview, RESPs and another giveaway

Canadian Capitalist — Fri, 05 Apr 2013 03:15:01 +0000

In a wide-ranging interview with Charlie Rose on PBS, Jeremy Grantham says that the era of 3 percent economic growth is over.

Jason Zweig says that automatic enrolment with opt-out can help alleviate the retirement savings crisis.

Rob Carrick says that you can give your kids their inheritance early by starting early and contributing regularly to a Registered Education Savings Account (RESP). It’s good advice because the Government kicks in at the very least an extra 20 percent.

Bitcoins were in the news this days as the value of these virtual coins soared in the wake of events in Cyprus. This blog post takes a deeper look into the strengths and weaknesses of Bitcoins.

As the old saw goes, investing is simple but not easy. This article offers ten tips for overcoming some common investment errors.

Larry Swedroe highlights the findings of a study that found that there is no special advantage to a strategy of investing in dividend-paying stocks.

Michael James calls value averaging — an investment strategy that involves adding or withdrawing money from a portfolio based on a pre-determined rate of return — “non sense”.

Canadian Financial Stuff says that he finds passive investing still means you have to pay attention to your portfolio. I tend to agree but it should be mentioned that the time demands of a passive portfolio are fairly minimal.

Google recently announced that it is shuttering the Reader product. Blessed by the Potato wonders why Google is killing off some of its useful products.

H&R Block Online Giveaway

Thanks to H&R Block, I am giving away five (5) online coupons for filing your family’s tax returns (valued at $23.95). To enter just leave a comment in this post and don’t forget to include a valid e-mail address. If you are reading this through your favourite RSS Reader or via-email, you have to click on the headline, get through to the website and scroll down to the bottom of the page and type in your comment.

Some quick rules:
(1) No purchase necessary. A skill-testing question may be required.
(2) Deadline for entries is 11:59 p.m. EDT on Tuesday, April 9, 2012.
(3) One entry per person please.
(4) I treat your privacy very seriously. Your email will be used for the sole purpose of contacting you if you happen to win.
(5) I’ll pick five (5) entries at random and announce the winner after the deadline. All decisions are final.

Related Reading:

This and That: Grantham Interview, RESPs and Another Giveaway is brought to you by Canadian Capitalist — Helping you to invest & prosper.

A look at the Performance of the BMO Covered Call Canadian Banks ETF (ZWB)

Canadian Capitalist — Wed, 06 Feb 2013 03:00:32 +0000

BMO launched its Covered Call Canadian Banks ETF (TSX: ZWB) in January 2011. The ETF immediately started attracting investor attraction. Investors were mesmerized by the initial annualized yield of 10% and piled money into the fund: among ETFs launched in 2011, ZWB ranked first by Assets under Management by a wide margin. Interestingly, the second most popular among ETFs launched in 2011 is another covered call product: the Horizons Enhanced Income Equity ETF (TSX: HEX). Investors had clearly developed a preference for income products.

It appears that many investors thought (or at least hoped) the higher yield from ZWB compared to a plain vanilla product like the BMO S&P/TSX Equal Weight Banks Index ETF (TSX: ZEB) would translate into higher total returns. Now that ZWB has a 2 year track record under its belt, we can analyze how ZWB’s returns stacks up against ZEB’s.

Performance for the 2-year period ending Jan. 31, 2013

BMO Covered Call Canadian Banks ETF (ZWB): 8.10%
BMO S&P/TSX Equal Weight Banks Index ETF (ZEB): 8.92%

We find that the Covered Call ETF under performs the Bank ETF by an annualized 0.82 percent over a two year period even though it is just 0.10 percent more expensive than the plain-vanilla ETF. In the following graphic, we break down the total returns from the two ETFs into income and capital gains.

The one year performance (for the period ending Jan. 31) of the Covered Call Banks ETF (ZWB) is compared with that of the Equal Weight Banks ETF (ZEB) in the following table:

	ZWB	ZEB
2012	2.84%	3.59%
2013	14.01%	14.52%

If we look at the income generated by these two ETFs as a percentage of starting NAV, we get:

Income generated for the 1-year period ending Jan. 31, 2012

BMO Covered Call Canadian Banks ETF (ZWB): 9.2%
BMO S&P/TSX Equal Weight Banks Index ETF (ZEB): 3.5%

Income generated for the 1-year period ending Jan. 31, 2013

BMO Covered Call Canadian Banks ETF (ZWB): 6.8%
BMO S&P/TSX Equal Weight Banks Index ETF (ZEB): 3.6%

In other words, though an investor earned a significantly higher current income with ZWB, she would have earned lower total returns compared to an investment in ZEB over the past two years. Also, the income an investor receives from the covered call ETF has been dropping: the fund started off with an annualized yield of 10 percent but two years later, the yield is just 5.6 percent. Granted, a two year time frame is too short to make a fair comparison of ZWB and ZEB but the early results show that just as we initially suspected, there is no free lunch here.

NB: This post was initially published on Feb 20, 2012. It was updated on Feb 5, 2013.

Related Reading:

A look at the Performance of the BMO Covered Call Canadian Banks ETF (ZWB) is brought to you by Canadian Capitalist — Helping you to invest & prosper.

Group RESP Plans are Loaded with Fees

Canadian Capitalist — Mon, 21 Jan 2013 19:39:56 +0000

In some of the long-running posts on this blog (for example, see Is a Group RESP Plan Right for You?), Group Registered Education Savings Plan — usually referred to as scholarship plans — cheerleaders (often sales people) continue to post comments on how Group RESP fees are a bargain compared to bank MERs. These cheer leaders conveniently forget that the mutual funds recommended by this blogger and other objective observers for RESPs feature Management Expense Ratios (MERs) of well under 0.5 percent. Parents saving for their child’s education in self-directed mutual fund RESPs at the big banks will find that the MER charged by the mutual funds is usually their only expense.

Let’s consider two new parents George and Simon. George opens up a Group RESP for his newborn and Simon opens up a self-directed RESP. We’ll assume that both George and Simon contribute $2,000 to their child’s RESP for the next 3 years. We’ll also assume that both RESP portfolios are invested in similar securities and the returns are flat over those years. Simon’s total expenses are straightforward to figure out. He invested a total of $6,000, earned Canada Education Savings Grants worth $1,200 and paid about $60 in fees over 3 years ($12 in the first year plus $24 and $36 in subsequent years).

George on the other hand is discovering that Group RESPs are loaded with fees. He counts the many creatives ways in which he is charged fees in a typical plan:

Insurance Premiums

The fee meter starts running before contributions even reach the Group RESP account. George has to pay for group life and total disability insurance. There are no opt-out provisions (except in Quebec) even if George has plenty of coverage through other sources. A typical Group RESP will deduct roughly 1.7 percent of contributions (plus HST) as insurance premiums. So, after deducting $38.50 in insurance premiums, only $1,961.50 is deposited into George’s Group RESP account.

Cost over three years: $116

Depository Fee

Group RESP vendors charge a fee for simply depositing a RESP contribution into the account. The fees depend on the frequency of contributions. Since George is making annual deposits, he will be charged $6.50 plus GST per year.

Cost over three years: $22

Enrolment Fees

And now for the sticker shock! George’s contributions to a Group RESP are used to purchase units. Since George wanted to contribute $2,000 over 18 years, he chose to make annual contributions. In George’s case, 1 unit is valued at $55, so George purchases 35.53 units ($1954/$55 per unit). Enrolment fees for each unit is $100 and over half the contributions of the first three years are used to pay the enrolment fees.

George has purchased 35.53 units, which means enrolment fees cost a stunning $3,553 and the $6,000 contribution over three years is reduced to a balance of just $2,309.

Cost over three years: $3,553

Just as an aside, it is worth noting that $67.50 per unit is paid as compensation to salesperson. In this example, the salesperson earned a commission of $2,407. Is it any wonder that the vast majority of Group RESP cheer leaders are the sale people, not the parents invested in these products?

It would only be fair to point out that some Group RESP plans guarantee a partial refund of the enrolment fee, which would lessen the impact of fee somewhat. However, parents should keep in mind that even a full refund of enrolment fees eighteen years down the line has a significant impact on the bottom line in terms of opportunity cost (income that would otherwise accumulate on the fees is foregone) and inflation (a dollar that will be received in 18 years is worth just 70 cents today if inflation is 2 percent).

Management Fee

Unfortunately, the fleecing isn’t over yet. Group RESPs charge a management fee of about 0.70 percent for investing and administering the account. Eagle-eyed readers will note that this fee alone is greater than the fees incurred in a self-directed RESP invested in low-cost mutual funds. Since enrolment fees eat up such a large portion of George’s contributions over the first three years, the management fees he pays out is also lower than the competition.

Cost over 3 years: $30

Bottom line on Self-Directed RESP and Group RESP Fees

The bottom line over the first three years is quite simple. The self-directed RESP incurred a total cost of just $60. The group RESP incurred a total cost of $3,721.

What about the next three years? The enrolment fees is fully paid up but the Group RESP still remains the fee leader. We’ll continue to assume that rates of return for both plans are zero. The self-directed RESP will incur total fees of $180. The group RESP will incur total fees of $265 (Insurance: $116; Depository fees: $22; Management fees: $127). You be the judge of which plan will cost you more.

Related Reading:

Group RESP Plans are Loaded with Fees is brought to you by Canadian Capitalist — Helping you to invest & prosper.

Performance of Currency-Neutral S&P 500 Index Funds

Canadian Capitalist — Tue, 08 Jan 2013 07:00:44 +0000

[Note: The following post was originally published on Jan 3, 2010. I've now updated it with the 2012 annual returns for XSP and IVV. The bottom line is that the performance of currency-hedged funds still lags that of the local currency fund by a significant margin.]

Many investors would like to have exposure to US stocks in their portfolio even if they believe that the US dollar is in a secular decline against other major currencies. In theory, currency-neutral funds seem to offer the best of both worlds: exposure to one of the world’s most dynamic stock markets without the baggage of the risk of a depreciating currency. However, if you look at the (short) performance history of currency-neutral funds, a different reality emerges.

First, let’s compare the returns of the iShares CDN S&P 500 Hedged to Canadian Dollars Index Fund (TSX: XSP) with the iShares S&P 500 Index Fund (NYSE Arca: IVV) in US dollars. In the following table, the annual total returns of XSP are listed in Column 2 and the total returns of IVV in US dollars are listed in Column 3. The performance between the two funds is compared from 2006 because in 2005 and earlier years, XSP was a clone fund that used derivatives to skirt RRSP foreign content rules that were in place at that time. While XSP’s MER of 0.25% is just 16 basis points (0.16%) higher than IVV, the difference in performance (shown in Column 4) is much wider.

A Canadian investor who put $100 (Canadian) in XSP in 2006 would be left with $114.72 at the end of 2011. A US investor who put $100 (US) in IVV, on the other hand, would be left with $114.03. In other words, the returns in XSP trailed that of IVV by an annualized rate of 2.08%. A Canadian investor betting that the C$ would appreciate against the USD and opting XSP over holding IVV directly would have been right on the first count but made no money on the bet by investing in XSP. The C$ appreciated at an annualized 2.1% against the USD but the tracking error of XSP wiped out pretty much all of the gains.

Year	XSP	IVV (in US$)	Difference
2012	15.56%	15.91%	0.35%
2011	1.07%	2.03%	0.96%
2010	13.47%	14.97%	1.50%
2009	22.95%	26.40%	3.45%
2008	-40.33%	-36.94%	3.39%
2007	3.23%	5.43%	2.20%
2006	14.30%	15.68%	1.38%
Average			1.89%

This pattern of the currency-neutral fund exhibiting significant tracking error can also be observed in the TD e-Series index funds. As you can see in the following table, the TD e-Series US Index Currency Neutral fund underperforms the TD e-Series US Index (US$) fund by an annualized 1.57%.

Year	TD US Index (CAD)	TD US Index – Currency Neutral	TD US Index (USD)	Difference
2012	10.90%	15.40%	15.20%	-0.20%
2011	4.10%	0.30%	1.50%	1.20%
2010	8.40%	12.60%	14.30%	1.70%
2009	6.70%	22.20%	25.70%	3.50%
2008	-21.70%	-39.00%	-37.40%	1.60%
2007	-11.10%	3.10%	4.90%	1.72%
2006	14.70%	14.00%	15.10%	1.10%
Average				1.54%

It is often asked why currency-hedged funds have exhibited such horrendous tracking errors. It turns out that the bulk of the blame can be attributed to the tendency of stocks and currencies to move in opposite directions (See post Why Currency-Hedged Funds have Large Tracking Errors).

So, what should investors do? If past performance is any indication and if investment performance is the only consideration, it appears that investors will likely be better off obtaining direct exposure to foreign equities without hedging away currency exposure. Owning foreign stocks directly has provided better returns in the past and it has done so with lower risk.

Related Reading:

Performance of Currency-Neutral S&P 500 Index Funds is brought to you by Canadian Capitalist — Helping you to invest & prosper.

Asset Class Returns for 2012

Canadian Capitalist — Wed, 02 Jan 2013 04:01:38 +0000

Despite the turbulence investors encountered throughout the year due to lingering problems in Europe and political wrangling in the US, asset class returns in 2012 turned out to be quite satisfactory. Bonds provided modest, low single-digit returns. Canadian stocks also provided modest, high single-digit returns. Foreign stocks had a banner year with returns from the United States, Developed Markets excluding North America and Emerging Markets all in the mid-teens despite the Canadian dollar appreciating modestly against the US Dollar.

REITs had another fantastic year returning 17 percent and extending the 24 percent, 22 percent and 55 percent win streak of the pervious years. One wonders how long the good times are going to last.

Asset Class	2012 Returns
CAD/USD	2.21%
DEX Universe Bond Index	3.60%
DEX Short Term Bond Index	2.01%
DEX Real Return Bond Index	2.85%
Canadian REITs	16.97%

TSX 60	8.07%
TSX Composite	7.19%

S&P 500 (in CAD)	13.49%
MSCI EAFE (in CAD)	14.78%
MSCI Emerging Markets (in CAD)	15.66%

If you are interested in asset class returns for previous years, Norbert Schlenker of Libra Investments maintains a spreadsheet of total returns for various asset classes going back to 1970.

Sources: Bank of Canada, PC Bond Analytics, MSCI Barra and S&P Dow Jones Indices.

PS: Note that percentage returns are inclusive of dividend or interest or distributions.

Related Reading:

Asset Class Returns for 2012 is brought to you by Canadian Capitalist — Helping you to invest & prosper.

Sleepy Mini Portfolio Q4-2012 Update

Canadian Capitalist — Wed, 12 Dec 2012 15:22:39 +0000

Since my previous update, the Sleepy Mini Portfolio has gained 3.75 percent due to a rally in the stock markets over the fall months. It is now just over five years since the Sleepy Mini Portfolio was launched in August 2007 with an initial investment of $1,000 with a target allocation of 20% bonds, 20% Canadian stocks, 30% US stocks and 30% International stocks. Another $1,000 was added to the portfolio every quarter since then for a total investment of $21,000. Here’s how the portfolio looks as of December 11, 2012:

TDB909 – Canadian Bonds – $4,629 (19.4%)
TDB900 – Canadian Equities – $4,738 (19.9%)
TDB902 – US Equities – $7,011 (29.4%)
TDB911 – International Equities – $7,457 (31.3%)
Total – $23,835
Total Invested – $20,000

The idea behind the Sleepy Mini Portfolio is to follow a mechanical investment strategy of committing savings to a long-term portfolio on a regular basis. Therefore, we will add another $1,000 to the portfolio and rebalance it to the original target allocation using this rebalancing spreadsheet. Here are the results:

Transactions

TDB909 – TD Canadian Bond Index (e-Series) – Buy units for $337.63.
TDB900 – TD Canadian Index (e-Series) – Buy units for $228.79.
TDB902 – TD US Index (e-Series) – Buy units for $433.58.

Inspite of the economic troubles in Europe, International markets have outperformed other markets over the past quarter. Therefore, we will skip making a contribution to the International stock portion of the portfolio.

Readers are often curious about the annualized returns of the Sleepy Mini Portfolio. It is easy to calculate using the XIRR function in Microsoft Excel. Plugging in the dates, contributions and the current portfolio value tells us that the Sleepy Mini Portfolio returned an annualized 5.3 percent over the past five years.

[NB: An earlier version reported the rate of return of this portfolio incorrectly as 7.2 percent.]

Related Reading:

Sleepy Mini Portfolio Q4-2012 Update is brought to you by Canadian Capitalist — Helping you to invest & prosper.