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Portfolio Management 5 - ETFs for your portfolio Print
Our site recommends investing in exchange-traded funds (ETFs) as a simple and inexpensive way to invest on an index basis. We are often asked what are the main ETFs traded on the stock exchange. In this fifth and last in our series of commentaries on portfolio management, we present the principal ETFs available for purchase by the Canadian investor. The investment philosophy of our site is set out under Our philosophy under the tab About us on our homepage. Among the elements of our philosophy you will find: investing to follow or track the market rather than trying to beat the market; minimizing one’s investment costs, and generally choosing the products preferred by institutional investors when available for investment by retail investors.

ETFs are the best product for an independent investor (if you have the profile, see Independent investor), who follows a similar philosophy; for more, see the section Index Fund (ETFs and index mutual funds) of our site. ETFs should generally form the core of independent investors’ portfolios; see Investopedia 2008 ETF portfolios doc.968. Ideally, you buy them through a discount broker to minimize your commission costs; see Alternative ways of investing. ETFs let you easily establish a portfolio of long-term investments (see Spence MarketWatch 2008 doc.969), meaning that you should not turn around and sell them for a quick profit because you think the market will be falling soon; see PrefBlog market timing 2008 doc. 970.

A word of caution

In order to justify excessive management fees (these fees are often referred to as the management expense ratio or MER), banks and brokers in the USA (the same phenomenon exists to a lesser extent in Canada) have recently created an endless number of ETFs which have mostly abandoned index investing; for more information, see the section ETF sector fund.

Barrons weekly (which is part of the same group as the newspaper Wall Street Journal) publishes a quarterly review of ETFs. The April 7, 2008 (p.lL59) issue lists 1,350 ETFs! This shows the extent to which things have gotten out of control. Our recommendation: avoid these newly created ETFs characterized by high MERs and which solicit you to invest in a limited sector of the market (or to invest in a venture which attempts to beat the market). In so doing, they are of course trying to convince you to drop ETFs with reduced MERs. We invite you to read the section of our site Costs of investing to see for yourself the importance of minimizing investment costs, and the section Beat the market? to appreciate the disadvantages of an active approach to investment.

Our advice: choose ETFs which pursue an index approach to investing, which attempt to replicate the results of wide, recognized markets and that maintain a very low MERs. The ETFs that we list in this commentary are based on this philosophy.

Most of the funds that are mentioned here have already been referred at various places on our site; to find these references, use the search function of our site (see under the Help tab on the home page).Our list of internet sites has a section on ETFs. In addition, our Stock Quotes function in the bottom left on our home page gives you the current market prices for many of these ETFs.

Canadian Market

ETFs are traded in Canada on the Toronto Stock Exchange (TSX, formerly the TSX); for more information, see the Canadian financial markets and the fixed income market on our site and the Canadian site of Barclay's Global Investors www.ca.ishares.com.

Below are the main ETFs traded on the TMX which invest in the Canadian markets for equities, debt securities and REITs (data at 20 06 2008; amounts of assets in billions). Their MERs are low, ranging between 0.17% and 0.55%, and their asset sizes are between $ 300 million and nine billion.

XBB- ishares CDN Bond Index Fund-CA $ 0.886B (DEX universal bond index);
MER 0.30%
This fund enables you to invest across the entire Canadian bond market. Our site recommends buying individual government bond, but the fund is a reasonable compromise if your total investment is modest or if you searching for simplicity at all cost: investing in bond funds?

XIU- ishares CDN Large Cap 60 Index fund-CA $ 9.68B (S & P / TSX 60 index);
MER 0.17%.
This fund invests in Canadian large-cap companies. It does not reproduce exactly the TMX Composite Index, but this fund is the Canadian heavyweight of ETFs, has a very low MER and is very popular with institutional investors. To track the full TMX composite there is the XIC ETF, but it is a much smaller fund, the market for its shares is less liquid, and it’s MER, although very reasonable (0.25%), is higher than the XIU MER. If you invested years ago in the XIU, and therefore have a very low cost base for tax purposes, it may be advantageous to make your new Canadian equity investments via the XIC, since these new investments will benefit from a higher cost for tax purposes at the time of resale.

XRE- ishares CDN REIT Index Fund-CA $ 0.332B (S & P / TSX Capped REIT index); MER 0.55%
This fund is an easy way to invest in the diversified Canadian commercial real estate rental market. Its MER is slightly higher than our preferred maximum of 0.50%; see Real estate ETF funds (REITs) - Canada.

XSB- ishares CDN short-term bond index fund CA $ 0.713B (DEX index short-term index); MER 0.25%
This fund may be used for your temporary short-term investing; see short term investing on our site, which discusses the disadvantages of having a cash portion of a portfolio invested for the long term.
Index mutual funds

There are mutual funds that share with ETFs an index approach to investing. We generally prefer ETFs, but that does not mean that index mutual funds are necessarily a bad choice, see ETFs and index mutual funds-a comparaison. We remind you that, unfortunately, U.S. mutual funds cannot be purchased by Canadians; see our commentary Canada retains its standing (last place!) in world mutual fund universe. Throughout our site, when we identify a particular Canadian ETF, we often also identify a similar index mutual fund; see for example, the sections on equity, debt and alternative investments.

The largest issuer of index mutual funds in Canada is the Toronto-Dominion Bank; its funds are sold mainly through its subsidiary, discount broker TD Waterhouse. Two postings (posting 1 doc.971 and posting 2 doc.972) on the site CanadianCapitalist identify TD Waterhouse index mutual funds corresponding to many of the ETFs listed in this commentary.


Non-Canadian Markets

The four ETFs traded in Canada discussed above allow you to easily establish a portfolio entirely invested in Canada. If you want to diversify your investments (advisable, given the lack of diversification of the TMX; see a lack of diversification), you can consider ETFs traded in the U.S. and which invest in the U.S. or in other foreign countries (other than Canada or USA). For the benefits of geographical diversification in your investing, see geographic diversification.

The Wall Street Journal publishes the beginning of each quarter the list of major ETFs traded in the U.S. The information given in this commentary on these ETFs is as of 31 03 2008, it originates from Thomson Financial and was published in the WSJ on April 4, 2008. These funds enable you to invest worldwide on an index basis in equity and debt securities and in REITs (real estate income trusts). Please note that some of these funds invest mainly outside of the U.S., even if their shares are solely traded in the USA.

The total assets of the 10 largest ETFs are huge: U.S. $ 248.1 billion. Their management expense ratios or MER, a key indicator of how much a fund investment costs the investor, vary between 0.07% and 0.20% for funds invested in the U.S. market, and between 0.35% and 0.75% for those invested in foreign markets. In summary, virtually all of these funds are very large and have very low MERs.

Foreign markets- the USA

USA equity markets

The following ETFs are traded on U.S. exchanges (for more, see the section American financial markets) and invest exclusively in US financial markets:

SPY (SPDR S & P500) - $ 82.3 billion in assets; MER 0.08%
This fund is huge (10 times the largest ETF in Canada) and has the lowest MER of all ETFs. It reproduces the main U.S. stock index. It is the U.S. equity ETF preferred by institutional investors and the one that we recommend for the U.S. portion of your equity investments. Two competitors are the IVV fund (ishares S & P500) and the VTI Vanguard fund (which invests in the entire US equity market), both of which are smaller and less known than the SPY.
In Canada there is an ETF which follows the same index as SPY. It is the fund XSP ishares CDN S & P500 index fund. The XSP fund has assets of $0.553 billion and a MER of 0.24%. Moreover, the XSP protects the holder against losses caused by any decline in the value of the Canadian dollar against the U.S. dollar. It seems that this currency protection cost an additional 0.50% per year; see article 2006 Canadian Business doc.973. So the total costs (MER + currency protection) are 0.74%, against 0.08% for the SPY. Do you want to pay this much more for this protection; it is up to you to decide.

There are other ETFs that invest based on alternative US indexes; these other indexes are well established but nevertheless of lesser importance than the S & P500; see American financial markets and investment returns and indexes. We do not recommend them instead of or in addition to the SPY unless you have a specific reason to do so. The main ones are:

QQQQ (Power Shares NASDAQ 100) $ 17.04B; reproduces the NASDAQ technology index.
IWF (ishares Russell 1000 Growth) $ 12.86B; reproduced index of medium-sized companies.
DIA (Diamonds) $ 10.83B; reproduced index well-known Dow Jones Industrial Average.
IWM (ishares Russell2000) $ 10.33B; reproduced index of smaller companies.
American debt markets

For those who want to invest in US dollar debt securities outside of Canada (see sections and foreign currencies and ETFs and foreign currency: in general), here are the main ETFs:

SHY (ishares Lehman 1-3 yr Treas.) $ 9.57B;
AGG (ishares Lehman aggregate fund) $ 8.63B;
TIP (ishares TIPS bond fund) $ $ 6.69N;
IEF (ishares Lehman 7-10 year) $ 2.70B;
TLT (ishares Lehman 20 + yr Treasury) $ 1.19B.

US REIT market

Here, for those who want to invest in US REITs (see Real estate ETFs (REIT)-USA), are the main ETFs:

VNQ (Vanguard REIT) $ 2.31B;
IYR (ishares Dow Jones U.S. Real Estate) $ 1.90B.


Foreign markets- non-USA

The following ETFs invest outside of Canada and the USA. They are traded on U.S. exchanges, unless otherwise indicated:

Equities- non-USA


EFA (ishares MSCI EAFE) $ 45.42B; MER 0.34%.
This is a huge fund popular with institutional investors, and represents an effective way to invest in the markets of developed countries based upon the index used by most institutional investors to measure their own performance on their own foreign investments; see markets of developed countries and investment returns and indexes.

In Canada there is an ETF which follows the same index as the EFA. It is the XIN ishares CDN EAFE Index fund. The fund has assets of $0.759 billions and an MER of 0.49%. Moreover, the Canadian fund protects the holder against losses caused by the loss of the Canadian dollar against the U.S. dollar. It seems (contrary to what we already thought) that the protection against losses on currency costs an additional 0.50% per annum; see by analogy the article by Canadian Business 2006 doc.973. So the total costs (MER + protection) are 0.99% against 0.34% for the EFA. Do you want to pay this much more; it is up to you to decide.

EEM (ishares MSCI Emerging Markets) $ 23.85B; MER of 0.75%
This is another huge fund popular with institutional investors, and represents an effective way to invest in emerging markets countries following the index used by most institutional investors to measure their own performance on their own investments in emerging countries; see emerging markets. The MER is relatively high and there are cheaper alternatives, but smaller and less well known; see article seeking alpha 2007 doc.974.
In Canada there is a relatively small index mutual fund, which aims to follow the same index as the EEM; see Canadian index funds.

Fixed income- non USA

Here, for those who want to invest in debt securities outside Canada and the USA (rare for the majority of Canadian investors), the main ETF is:

BWX (International SPDR Lehman Treasury Bond fund) $ 0.74B


REIT non-USA


Here, for those who want to invest in REITs outside of Canada and the USA (again, rare for the majority of Canadian investors; see Real estate ETFs- foreign markets), the main ETF:

RWX (SPDR DJ Wilshire Real Estate Int'l) $ 0.97B


Conclusion

We hope that this series of commentaries on portfolio management has been interesting and will help you to become better do-it-yourself investors. Remember that your choice of ETFs or other investments in your portfolio should always follow the Asset Allocation that suits you best; see asset allocation. The fact that an ETF is listed in our commentary is not an investment recommendation; see Terms and conditions. It is up to you, as an independent investor, to decide whether one or several of these funds are appropriate for your portfolio. Good luck in the management of your portfolio.
Last Updated ( Monday, 01 September 2008 )
 
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