Drilling down into the iShares Core ETFs

It may be premature to switch from XSB and XBB to cheaper alternatives

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When iShares launched its Core ETF series back in March it made some waves in the industry. The company cut the fees on nine ETFs it considers building blocks of a long-term portfolio. Its boldest move was to slash the cost of one of its flagship products, the iShares S&P/TSX Capped Composite (XIC). At the time XIC was weighed down by a management fee of 0.25%, much higher than its competitors from Vanguard and BMO. After that fee was reduced to a stingy 0.05%—making it the cheapest ETF in the country—it prompted BMO to follow suit less than a month later.

Now more moves are afoot. On July 21, iShares rebranded these nine ETFs to include “Core” in their names. They also launched a new addition to the family: the iShares Core Short Term High Quality Canadian Bond (XSQ).

The new ETF is extremely similar to the iShares Canadian Short Term Bond (XSB) in most respects: both are about 60% government bonds and 40% corporates, and the holdings are all investment-grade (rated A or higher). Their fundamentals are almost identical:

XSB XSQ
Yield to maturity 1.58% 1.55%
Average coupon 2.98% 2.81%
Duration 2.83 2.77
Average term 2.83 2.92

Source: BlackRock Canada

The big difference between the two ETFs is the management fee. While XSB charges 0.25%, the new Core product comes in at less than half that: just 0.12%.

BlackRock has also changed the name and ticker symbol of the former iShares High Quality Canadian Bond (CAB), which is now the iShares Core High Quality Canadian Bond (XQB). This fund has a similar makeup to the much older iShares Canadian Universe Bond (XBB), but again, the key difference is cost. XBB has a management fee of 0.30%, while the new XQB costs just 0.12%.

Harnessing the power of inertia

These moves have prompted some critics to wonder why iShares didn’t simply make XSB and XBB part of the Core family. Instead of creating what are essentially clones of existing ETFs, why not just cut the fees on the incumbents?

The business reasons seem obvious. XSB is the second-largest ETF in Canada with a whopping $2.35 billion in assets, while XBB has about $1.54 billion. Cutting the fees on those funds to 0.12% would cost BlackRock about $5.8 million a year. By launching parallel ETFs instead, they can offer a lower-fee option without losing the revenue from investors who are already holding XBB and XSB. Sure, investors could simply switch from one to the other, but most will follow Newton’s First Law of Motion and simply accept the status quo out of ignorance or laziness.

So if you hold one of the older bond funds, should you switch to XQB or XSQ? Certainly it’s worth considering, though I’d like to see a year of data to make sure the funds do indeed perform similarly. XBB and XQB are not identical: the latter is about 60% government bonds, while the former is closer to 70%. The differences between the short-term bond ETFs seem smaller, but I’d still watch them for a while before committing.

It’s also worth keeping an eye on their bid-ask spreads. In theory, the size and trading volume of an ETF isn’t supposed to affect its liquidity, but in practice it often does. XQB has gathered about $68 million in assets but still has low volume and an occasionally wide bid-ask spread, and the brand-new XSQ will take a while to acquire any volume at all. As always, place your trades thoughtfully and always use limit orders.

One comment on “Drilling down into the iShares Core ETFs

  1. There are other factors to consider such as “skid” or trading spread (the difference between the bid and ask price), tracking error, taxes and commission to buy and sell. With interest rates so low, it makes sense to have a process in place for each of these. Some of the less liquid but “cheaper” ETFs will end up costing much more in skid than you save with a more expensive but more liquid ETF or even open end fund.

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