Tuesday, 8 December 2009

ETF Comparison: Canadian Large Cap Equity Funds

ETFs are steadily rising in popularity as Larry MacDonald described recently in ETFs Pulling Ahead on Canadian Business. The traditionally dominant iShares funds are starting to get some significant competition, first from Claymore Canada, which entered the market a few years ago, then from Horizons BetaPro and most recently from BMO Financial Group.

It is an opportune moment to compare the ETF entrants in one of the main portfolio building blocks - Canadian Large Cap Equity, which makes up just over 70% of the total value of TSX listed stocks. In Canada, the usual measure of large cap is the 60 largest companies by market capitalization on the TSX.

  1. iShares™ CDN LargeCap 60 Index Fund (Symbol: XIU) - the ETF that has attracted the most investor money by far and the oldest too. As a passive tracker of the S&P TSX 60 index, it mimics the TSX 60 as closely as possible.
  2. BMO Dow Jones Canada Titans 60 Index ETF (ZCN) - the newest entrant, on the market only since May 2009 but backed by financial industry heavyweight BMO Financial Group. Another passive index tracker though it uses the Dow Jones Index which also adjusts for the market float and trading volumes differently than the S&P method, though the holdings end up very similar to XIU and so will the performance.
  3. Claymore Canadian Fundamental Index ETF (CRQ) - has been around for a few years and tracks a different index, called the FTSE RAFI Canada Index, whose methodology relies on accounting factors to weight which companies are worth investing more or less in. As a result, its 65 holdings and market performance diverge considerably from the other three ETFs.
  4. Horizons AlphaPro Managed S&P/TSX 60 ETF (HAX) - launched in January 2009 it is one of the first actively managed ETFs, where the managers use their wiles to try to outperform through picking and choosing from the top 60 stocks. Some drastically different weightings result.
Key Comparison Factors (click on table below for details):

Management Expenses (MER) - BMO's ZCN is lowest by a hair at a miniscule 0.15% versus iShares XIU's 0.17% while the other two are significantly higher - by 0.5% or more.

Trading and Rebalancing - With an index that rebalances only annually, ZCN should incur less trading commission costs (which are borne directly by the fund and are not included in the MER) and possibly even fewer capital gains distributions than XIU or CRQ and a lot less than Horizons' HAX, which can be expected to have much higher turnover from its active management strategy. Time will tell tell if that turns out to be true.

Size, Liquidity, NAV Discount - Size does matter with ETFs. A bigger fund means tighter bid-ask spreads (i.e. a slightly higher price when you sell at market and a lower price when buying at market), easier trading of larger amounts of shares and a smaller difference between the net asset value (NAV) per ETF share and its market price. As a small fund, ZCN is at a disadvantage compared especially to XIU, which is easily the best on these factors, but that may change if (as?) ZCN grows to a respectable size. CRQ also suffers from a size disadvantage compared to XIU. HAX is tiny, almost to the point of not being viable.

Holdings - ZCN and XIU are much less concentrated than CRQ and HAX. The top 10 holdings make up only 47% of the total portfolio while CRQ and HAX are up around 55%. ZCN and XIU hold almost all the same companies - only seven are different in the two lists - and very closely in the same order and weightings (green cells in the chart below). CRQ and HAX are quite different from each other. HAX's latest published list (a demonstration of its lesser transparency compared to the other three ETFs, which update their online holdings list on a daily basis) of September 30th holdings suggest that the managers are bullish on gold and energy, with significantly higher allocations to gold mining and energy companies.

Features - CRQ offers the investor the most convenience through optional plans to have dividends automatically reinvested (DRIP), or for automatic purchases through pre-authorized chequing (PACC), or for automatic regular withdrawals (SWP - Systematic Withdrawal Plan). These also save the investor the commission cost for buying or selling. ZCN offers an optional DRIP, while HAX makes dividend reinvestment mandatory. XIU has no such features at all.

Tracking Error - this is the measure of how well the ETF mimics its index, obviously, closer being better. XIU does best on this score with a very small annual under-performance. ZCN's has been quite high over and under in its short existence. Will ZCN's improve with time? Claymore does not supply a tracking error chart for CRQ, a negative in this writer's view. For HAX tracking error is not relevant since it explicitly does not aim to track any index.

Performance - so far, at least, HAX is not living up to its objective to outperform the TSX 60 index, as shown by this Google Finance chart.

On a year to date basis to October 2009, CRQ has done far better than XIU or HAX, as this chart shows.

Great, we might think, that's the best fund. Just a minute, here is a longer term chart going back to the 2006 start-up of CRQ. There was a time in 2008 that XIU leaped far ahead of CRQ and overall XIU and CRQ have provided about the same return in the past four years. What will the future bring?

Which ETF is Best?
In the absence of proven long term superiority of the alternate RAFI index or of active management, my preference is for the lesser concentration and the lesser costs of XIU and ZCN. XIU is a proven performer but ZCN is a credible alternative and has the additional convenience, not available for XIU, of automatic no-commission dividend reinvestment. The other convenience features of CRQ (SWP and PACC) may be attractive to some investors. HAX is for those who have faith in the unproven ability of its mangers to outperform and justify its higher fees. Hopefully, this comparison gives readers a sound footing for making their own choice.

Whatever your preference, all investors can only benefit from the increased choice of types of funds and from the competition amongst suppliers.

Disclaimer: this post is my opinion only and should not be construed as investment advice. Readers should be aware that the above comparisons are not an investment recommendation and that past performance may not continue, costs may change and other comparative factors like taxes may alter their value to you. Do your homework before making any decisions.


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