Tuesday, 22 February 2011

A Compendium of ETF Resources

Exchange Traded Funds are continuing to explode in popularity - the 52 new ETFs created during 2010 in Canada accounted for 28% of new listings on the TSX. Canada is part of a worldwide phenomenon. The worldwide growth of ETFs was only momentarily interrupted by the 2008 crash as the chart below from a TSX presentation dramatically shows. Assets and trading volumes are rising accordingly.

ETFs have many strengths and good points, but not all ETFs are necessarily good or appropriate for individual investors. Along with the proliferation of ETFs, there is a proliferation of online content about them. To save readers time and effort to track down good information on ETFs, we offer a compendium of resources that we believe can help.

Canadian ETF Providers
  • iShares Canada - largest provider with broad range of cap-weighted index funds - including the most popular ETF in Canada the S&P / TSX 60 Index (XIU) - along with growing numbers of sector funds and foreign funds, many with currency hedging
  • BMO Financial Group - a series of sector and sub-sector specialized funds, using features such as equal weighting, currency hedging, target maturity, income-orientation
  • Claymore Canada - fundamental weight index trackers plus range of sector and income-oriented funds and a few portfolio funds
  • Horizons AlphaPro and BetaPro - the place for actively-managed, leveraged, inverse and other strategy funds
US ETF Providers
The following are only the biggest (by assets) providers in the USA. There are many others - we counted 42 total ETF providers in one list.
Articles, News, Analysis, Research
Model Portfolios - basic, passive ETF portfolios to get started
Portals, Search and Filtering Tools, Quotes, Comparison Data
Most of these sites also include ETF basics - what they are, how they work, how they can serve the individual investor. Wikipedia has an entry on ETFs with basic information.
Canadian Taxes
Discussion Forums - Ask questions, likely someone will know the answer
As always, we may have missed some good resources - if we have, post a comment as other readers would no doubt also like to know what you do. Happy and productive reading to all!

Disclaimer: this post is my opinion only and should not be construed as investment advice. Readers should be aware that the above comments are not an investment recommendation. The sources' accuracy is not guaranteed and the article may not interpret their quality correctly. Do your homework before making any decisions and consider consulting a professional advisor.

Tuesday, 15 February 2011

Five Reasons to Go Beyond the One-Stop-Shopping Portfolio

Readers of last week's post might wonder why an investor might want to do anything else than buy one of the all-inclusive portfolio funds we examined. The simplicity, convenience and effectiveness of those funds notwithstanding, there are a number of reasons that an investor could want to build a more complex portfolio and do the required extra work.

1) Additional Asset Classes for Extra Diversification - We noted that some of the funds had no holdings in REITs, emerging market equities, real return bonds, commodities and/or gold, preferred shares and US / other foreign bonds. Including such other types of less correlated (i.e. tending to move out of sync with each other other) assets will lower the portfolio's variability and increase returns slightly (see this post at CanadianFinancialDIY). The ability to pick asset classes gives the investor the opportunity to deliberately exclude some - like commodities - that are in the more complex all-in-one portfolios but which do not garner universal support as a mainstream portfolio holding (see this post on the pros and cons). Or it allows the inclusion of some that certain investors desire for matching their circumstances, such as retirees wanting real return bonds (see this post for more).

2) Ability to Tailor Percentage Allocations to Each Asset Class - With the all-in-one portfolios, you must take the fund as it is. That is most likely not optimal for every individual. A person's spending goals and risk tolerance should have matching characteristics in the portfolio. For example, as you get closer to the time when the money will be spent, be that retirement or something other, and when the saving goal is closer to being reached, a rising proportion of more and more stable investments (equities > bonds > T-bills) should be in the portfolio. Our post on Asset Allocation has links to tools that can guide you for your own circumstances.

3) More Selectivity in Funds for Each Asset Class - It is not possible to pick which specific funds are held in the all-in-one portfolio to represent each asset class. The internal funds may not be the best in class for each category. As our various reviews of ETFs for such categories as Canadian Bonds, Canadian Large Cap Equity, US Large Cap (S&P 500 or similar), Commodities, and Emerging Market Equity (Canadian- or US-traded) show, there are many choices and differences.

Some equity markets may be better represented by a total market fund instead of only a large cap fund like those based on the S&P 500 (see discussion here) or the TSX 60.

It may be better to buy real return bonds directly and not in a fund, or even individual bonds in a ladder (ladder pluses, fund pluses).

There are arguments for and against funds based on alternative weighting and selection criteria such as equal and fundamental weighting.

Some foreign funds are hedged and others not, another choice which has pros and cons. The investor has many possibilities for making a better portfolio.

4) Rebalancing - All the all-in-one funds rebalance the portfolio quarterly to maintain risk at a constant level. It is possible and perhaps desirable to rebalance less frequently such as once a year, or even less often (as we discussed here) to gain slightly higher returns.

5) Tax Benefits by Splitting Holdings Between Registered and Non-Registered Accounts - When there is no room left in tax-deferred registered accounts, investments generating interest income, such as bonds, should go into the registered accounts while those generating dividends and capital gains, such as equities, belong in a non-registered account (see TaxTips.ca guidelines for which investments in which account). Splitting types of investments up for tax savings is obviously not possible when one fund contains all types of investments.

All these refinements require extra work of course, but the payoff should be a portfolio with better returns (try a compound interest calculator to see how much difference a small extra return can make when compounded over many years e.g. 3.5% vs 3.0% for 35 years gives you 18% more at the end) and less variability that is better adapted to your individual circumstances.

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. They rest on other sources, whose accuracy is not guaranteed and the article may not interpret such results correctly. Do your homework before making any decisions and consider consulting a professional advisor.

Tuesday, 8 February 2011

One-Stop-Investing for Your RRSP Contribution(s)

Contributing money to your RRSP is only the first step that gets you the tax refund. It will be a waste of time, since you have to pay the tax back upon withdrawal, unless the funds are invested so that they grow over the years (see our previous post comparing RRSPs with TFSAs, RESPS and non-registered taxable accounts for comments on what makes RRSPs worthwhile). The multitude of investment choices available, uncertainties about the economy, the mechanics of making the investment purchase, all can prove daunting, even too overwhelming, leading to no action and no investment, as we noted in Investing Success: More is Less, Less is More. That's bad, so we offer some solutions - ultra-simple, all-in-one, low-cost, auto-pilot, do-it-once-and forever, well-diversified and, of course(!), online.

First, and very importantly, we assume that the investor will be holding these funds in an RRSP i.e. with the goal of retirement and no selling out for at least next ten years (see our post on Setting Investment Objectives for discussion on how goals should shape the choice of investment) . That allows us to include a healthy dose of highly-variable-in-the-short-term-but-faster-growing-in-the-long-term equities amongst the assets. That also means we do not need to consider tax consequences of equities vs bonds vs foreign income as there are no taxes to pay (even US withholding taxes) while the money is within the RRSP.

The solution we propose is portfolio funds, ETFs and mutual funds, bought through a single purchase, that contain a whole gamut of types of assets and thousands of securities within.

Our Five Portfolio Funds
We have chosen five candidate funds (acknowledgements to Bylo Selhi for his list of low-cost index funds where the mutual fund choices were located) - two ETFs and three mutual funds. Our comparison table got too large for one screen and we had to split the ETFs from the mutual funds into two tables below, but we will do our comparisons of all five together.
Comparison Tables
1) ETFs - CBN and XGR

2) Mutual Funds - TDB965, INI230 and CIB901

Other Funds - There are other low-fee broadly diversified mutual funds that could fit into our criteria e.g. Mawer Canadian Balanced RSP, Mawer Canadian Diversified Investment Fund and RBC Monthly Income. We have focused on funds with an indexing strategy. To compare other funds, do a search in the Tools on Morningstar Canada's Funds page.

Diversification, Volatility and Returns - Diversification means having, a) many under-lying securities from different governments and companies inside the portfolio, to reduce the bad effects of trouble in any one organization, b) many different types of securities, or asset classes, to gain the stability and possibly higher returns, from having investments that do not all move in the same direction, especially when it is downwards, at the same time (see previous posts here and here).

All our funds have literally thousands of holdings within, mostly by holding other funds with lots of holdings, so all do a good job of reducing individual organization risk. All our funds also perform all the internal portfolio management for the investor, buying and selling individual stocks and rebalancing on a quarterly basis to keep within target allocations.

A big caution, since we cannot be sure what kind of long term results it will produce, is that iShares actively manages XGR - it varies its percentage allocation among the asset classes quite a bit instead of the passive indexing of all the other funds.

Asset Classes: CBN and XGR are appreciably superior to the three mutual funds by incorporating a number of important asset classes that are completely absent from the mutual funds - real estate, commodities, emerging market equities (China, Russia, Brazil etc that are not in EAFE) and some distinct sub-groups of fixed income like preferred shares, high-yield bonds, real return bonds and foreign market bonds (all excluded from the DEX Universe bond index definition).

Currency Hedging: The large foreign bond holdings in XGR explain its high percentage of foreign currency hedging - in order to protect the higher foreign bond returns from being eaten up by possible rises in the Canadian dollar, that portion of the portfolio gets hedged. CBN hedges its foreign bonds too while the mutual funds contain no foreign bonds to hedge. On the other hand, none of the funds hedges the foreign equities, which we tend to agree with (see post here). Hedging is thus a neutral factor in comparing the funds in our view.

Equity - Fixed Income Split: This is the most significant factor differentiating the five funds, though it isn't necessarily good or bad if one recognizes and is prepared to live with the volatility effect. The fund with the most equity, CBN, is also the most volatile, overcoming, it is interesting to note, even the stabilizing effect of having more asset classes during the extreme stress period of the 2008 financial crisis, as the chart below vividly shows (we had to omit XGR to do a fair comparison since it only started up in November 2008 after the worst of the crisis). CBN is the blue line and it followed the purple line of the TSX Composite down.

However, on the rebound, it is rising faster than the other funds, as the next chart below of the recovery period since January 2009, shows. The one year returns (see Comparison table) to December 31st, 2010 reflect that as well, with CBN in the lead.

Over the long term of ten years or more, the success of TDB965 and CIB901 will depend much more on the strength of the Canadian stock market due to the much heavier weighting of Canadian equities. INI230 places investor money evenly across its Canadian, US and EAFE equity holdings. CBN and XGR have very little in Canadian equity by contrast; the investor's success depends on how foreign holdings do.

TDB965's track record since its 1998 inception has been solid if not spectacular - 4.7% per year. Founded in the same year, CIB901 lags that at only 3.9% per year. CBN only goes back to mid 2007. That was just before the financial crisis, so it is no surprise that the return since inception is a loss of 3.8% per year.

Costs and Convenience
XGR is the low-cost leader at a Management Expense Ratio of only 0.62% with CBN and TDB965 0.2% higher and INI230 and CIB901 another 0.2% or so above that.

However, XGR lacks all the features to ease the on-going investment work for the investor. In contrast, CBN, TDB965, INI230 and CIB901 all have automatic no fee dividend reinvestment mechanism and automatic pre-authorized no extra fee fund purchase plans for regular small amounts. (Note that not all brokers have opted in to the auto purchase plan for CBN - check this table from Claymore). Reinvested dividends make up a very significant part of the total long term return of equities, as we discussed here, so having it done automatically, instead of the dividends sitting in cash which is too easily neglected and forgotten, is a big plus. The three mutual funds have the additional feature that all the tracking of Adjusted Cost Base is done by the mutual fund company, whereas with CBN and XGR, the investor must do that once a year for him/herself, as we described here.

Bottom Line - We find XGR to be less attractive than the others due to the active management and the lack of automatic features. All four of the other four funds are an effective choice in our opinion (and that is our opinion only, you should always think for yourself and possibly consult others to get alternate views), we like CBN and TDB965 for their low fees. CBN is more for those prepared for the bigger swings from a higher equity content, i.e. those in it truly for the long term who will not get too nervous when markets experience big declines. TDB965 suits the slow and steady crowd who are willing to sacrifice a possible, though not assured, higher end result for interim greater stability.

The most important thing is to invest in something. Comic Woody Allen spoke truly when he said "Eighty percent of success is showing up."

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. They rest on other sources, whose accuracy is not guaranteed and the article may not interpret such results correctly. Do your homework before making any decisions and consider consulting a professional advisor.

Tuesday, 1 February 2011

Share Repurchases vs Cash Dividends - Ins and Outs

Cash dividends and share repurchases are described as ways of returning money to shareholders (e.g. Still Waiting for the Payout in the Financial Post) but they differ substantially as to mechanics and the potential effect on stock value.

Trend - More Repurchasing Compared to Dividends
Decades ago, company spending on repurchases amounted to very little compared to dividends but there has been a steady, almost un-interrupted rise over the years. NYU professor Aswath Damodaran's Musings on Markets blog post Stock Buybacks: What is happening and why? has a great chart that plots dividends and repurchases from 1988 to 2009 in the bellwether US stock index, the S&P 500. After the exceptional reversal in 2009 due to the financial crisis, 2010 has seen a rebound in the dominance of buybacks according to the S&P report covering up to the 3rd quarter. In Canada, the sources in the Financial Post article say it is much the same (unfortunately, there is no parallel report by S&P for the TSX). No one expects the trend to reverse, so investors must understand and deal with buybacks substituting for dividends.

Cash dividends
are familiar to most investors and easy enough to understand. Some of the key features:
  • A company pays out cash to all shareholders, usually out of its earnings
  • Regular payments, most often on a quarterly basis.
  • On-going expectations - Once a quarterly amount has been set, shareholders and company management expect that the dividend will continue to be paid regularly quarter after quarter and increase as profits increase. Often companies set a formal policy for the percentage of earnings to be paid out. Cuts in dividends usually signal a bad turn in company fortunes.
  • Analysis is mostly about the cash flows and profitability of the business - whether a company's dividend is too high or too low and whether it is sustainable.
  • Dividend data is readily available as any stock quote will show the amount of the current dividend and the dividend yield, which is the current annual dividend as a percentage of the share price. There is even a weighted average dividend yield readily available for the overall stock market - for instance, according to the official Toronto stock market website TMX.com as of January 28th, 2010 the S&P/TSX Composite Index dividend yield was 2.44%.

Share repurchases, also known as stock buybacks, differ in a number of ways:
  • Repurchase cash goes to a limited number of shareholders, the ones from whom the company buys the shares. The normal method for buying the shares is on the stock market at the going price in a Normal Course Issuer Bid (NCIB). Since this occurs on the stock market, the sellers do not know that they are taking company cash as opposed to another investor's but the effect is still that all shareholders do not directly receive the company cash.
  • Repurchased shares are then cancelled (almost always this is the case, though the company could hold them on the books as Treasury shares), which reduces the number of shares in circulation. Fewer shares and the same earnings increases earnings per share, normally a good thing that would increase share price but the reality is more complicated than that, as we explain below.
  • Each buyback is different - dollar and percent of share targets vary and actual purchases may not match announced intentions. There is a constraint in Canada that NCIB purchases may not exceed 5% of outstanding shares within any 12 month period (see law firm Davies, Ward, Phillips and Vineberg's Revised Canadian Take-over Bid and Issuer Bid Regime). Repurchases, even announced, are voluntary and flexible. A direct issuer bid may also be made direct to shareholders at a fixed price, which may be above market price. After announcing an intention to buy back stock, the company is not obliged to do so and may buy only a portion or no stock at all.
  • Analysis considers multiple factors simultaneously - share price over- or under-valuation, company leverage/debt levels (some buyouts are done with borrowed money), capital gains vs dividend tax rates, management/employee options, company waste or productive use of cash
  • Data is only available piecemeal - a company intending to buy back stock is obliged to announce the amount and timing in advance through a news release, and that seems to be the only way to get data - company by company through a news release source.
The Why's of a Repurchase - Good or Bad?
As the above implies, every repurchase is different. Sometimes it is good for the shareholder investor and sometimes not. The different factors that come into play and ideas for ways to assess them include:
  1. Management / Employee Stock Options - Some companies, the worst culprits being in high technology (see S&P report above), routinely issue large numbers of stock options as compensation. The buyback then mops up the excess in shares created when the options are exercised. That may be fine if the compensation occurs in a high-growth company whose earnings rise fast enough to reward the public shareholders as well. Or it may be bad if it only amounts to diversion of profits away from shareholders towards the managers/employees. Checking the company financial statements will reveal the presence of options issuance and then assessment can move to other factors.
  2. Leverage or Debt / Equity - Sometimes companies borrow money to fund repurchases (e.g. Potash Corporation recently issued $1 billion in new debt to pay for half the $2 billion repurchase program announced in November). As Prof. Damodaran points out in another post Buybacks and Stock Prices: Good or Bad News? whether that is good or bad depends on the company having too much or too little debt to begin with. Adding debt to the point of too-much raises risk of default and will lower stock price while adding when there is too-little promises to increase profits for shareholders and thus the stock price.
  3. Shares Under-Priced or Over-Priced - A good reason for buying back stock is if management thinks shares are under-priced and it is true. The purchase is a way of saying it to investors in the market. If not believed immediately by the market, existing shareholders will benefit from higher profits later, which presumably would be followed by higher actual dividends and/or share price. If believed immediately, share prices will rise right away to reflect the true valuation of the company to the benefit of existing shareholders. If insiders are buying while a share repurchase is underway, it is a confirming signal that management believes the under-priced story.
  4. Uncertainty about Earnings - The flexibility of buybacks to match volatile earnings instead of the more locked-in nature of cash dividends may better suit businesses in cyclical sectors or those where deregulation has reduced predictability. To that extent it may be perfectly ok.
  5. Taxes on Dividends vs Capital Gains - This is the argument that some types of investors like hedge funds prefer to receive profits as capital gains over dividends. There is more skepticism than belief about this factor as a driving force in the trend. Its impact depends on one's own tax circumstances.
  6. Cash Being, or Likely to be, Wasted by Management - The current situation where large amounts of cash are apparently sitting on corporate balance sheets raises the question of how profitably it will be deployed. Ironically, if management decides that it cannot do better than give the money back to shareholders through buybacks and investors agree, there may well be a positive boost to the stock price. Prof. Damodaran suggests a good place to start looking for cash efficiency - large, established, mature companies with poor returns on assets and little debt may benefit from repurchases. High-growth companies with strong returns on assets and little debt capacity may suffer a stock decline if cash is returned through a buyback since that may be a signal that the future will not be as rosy as the past.
How to Find the Companies Doing Repurchases
  • Canada - Enter the word "repurchase" as the search term in the news release site CNW; then look through the resulting list which appears with recent announcements first. That's how we compiled the list below.
  • USA - The Online Investor maintains a handy list, though of course its completeness and accuracy must be checked
  • Individual Companies - check the Investor section of the company website for the complete details in press releases and financial statements
Recent Canadian Repurchase Examples

Bottom Line
Each repurchase by each company must be assessed individually for what factors are at play and how they will work out. Uncertainty of analysis and eventual outcome will always exist but the effort is worthwhile since something notable is being revealed about the company that regular cash dividends do not impart.

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. They rest on other sources, whose accuracy is not guaranteed and the article may not interpret such results correctly. Do your homework before making any decisions and consider consulting a professional advisor.