Did Your ETF Just Get Riskier?

One of the problems with actively managed mutual funds is that you can never be sure that the risk level will remain constant. In an income fund with a mix of government bonds, high-yield corporate bonds and dividend-paying stocks, for example, the exposure to these asset classes can vary according to the manager’s whims. Well, [...]

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One of the problems with actively managed mutual funds is that you can never be sure that the risk level will remain constant. In an income fund with a mix of government bonds, high-yield corporate bonds and dividend-paying stocks, for example, the exposure to these asset classes can vary according to the manager’s whims. Well, it turns out that same is true of some ETFs.

The iShares Diversified Monthly Income Fund (XTR) uses several other iShares ETFs to offer a blend of “income-bearing asset classes, including, but not limited to, common equities, fixed income securities and real estate investment trusts.” The fund’s web page makes it clear that “BlackRock Canada will review, and may adjust, XTR’s strategic asset allocation from time to time, as market conditions change.” However, in practice, the fund’s asset mix has remained virtually unchanged since its launch in August 2010.

But not anymore. XTR recently made a big shift that has significantly changed its risk profile (hat tip to reader Alec P. for pointing this out). Here’s how the fund’s holdings have changed:

Holding Feb 29 March 22
iShares S&P/TSX 60 (XIU) 15.0% -
iShares DJ Canada Select Dividend (XDV) 14.6% 5.0%
iShares S&P/TSX Equity Income (XEI) - 10.0%
iShares S&P/TSX Capped REIT (XRE) 14.5% 8.6%
iShares S&P/TSX Capped Utilities (XUT) - 9.9%
iShares S&P/TSX North American Prefs (XPF) 11.8% 6.1%
iShares US High Yield Bond (XHY) 9.1% 17.0%
iShares DEX HYBrid Bond (XHB) 8.9% 20.2%
iShares DEX All Corporate Bond (XCB) 8.8% 20.1%
iShares DEX Long Term Bond (XLB) 8.7% 3.0%
iShares DEX All Government Bond (XGB) 8.6% -
Canadian bonds 35.0% 43.3%
US bonds 9.1% 17.0%
Canadian equities 29.6% 24.9%
REITs 14.5% 8.6%
Preferred stocks 11.8% 6.1%

A major shift

The biggest change is a doubling of the exposure to high-yield bonds (via XHY and XHB), from 18% to more than 37%. The allocation to government bonds, meanwhile, has fallen from more than 17% to just 3%. The fixed income side of the portfolio is clearly a lot riskier than it had been for the last 18 months or so.

The greater allocation to high-yield bonds is offset somewhat by the lower allocation to equities, which has fallen from over 55% to less than 40%. By dropping XIU (which has about 34% in banks and less than 1% in utilities) and adding a 10% allocation to XUT, the portfolio now has a dramatically different mix of sectors, too. Reducing the holding of XDV (55% financials) and adding XEI (31% financials) also reflects a move away from the big banks.

All of this highlights the problem with investing in ETFs that do not track an index. Granted, XTR’s asset mix is not subject to the whims of a fund manager and her worthless forecasts: it’s based on a series of quantitative screens “designed to identify and optimally diversify portfolio exposure” within prescribed limits. But this is still tactical asset allocation, a strategy commonly employed by active managers, and one that is of dubious value to investors.

XTR isn’t the only fund that makes tactical shifts according to market conditions: the iShares Core Portfolio Builders and Claymore CorePortfolios also do so. While these “ETFs of ETFs” offer one-stop diversification at low cost, investors need to check in once per quarter to make sure they are still comfortable with the risk levels. Or, better yet, consider building your own ETF portfolio using a long-term asset allocation that doesn’t rely on guesswork.

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