Friday, 23 March 2012

Canadian Large Cap Equity Index ETFs Update - Surprises for Investors

Diversified large cap equity index ETFs are a key building block of the portfolio of most investors. When we last looked at this category of ETFs in September 2010 (see also original comparison in December 2009), the Horizons BetaPro TSX 60 tracker (TSX symbol: HXT) had just joined the fray. There have been some significant changes since:
  • HXT looked like an intriguing concept but it had no track record to judge it by. Now there is eighteen months of data. How is it doing?
  • Massive US-based fund company Vanguard has launched a Canadian operation and a flagship fund in the large cap space, the Vanguard MSCI Canada Index ETF (VCE). Does it look attractive and how is it likely to perform versus the others?
  • Horizons in June 2011 merged the AlphaPro Managed S&P/TSX 60™ ETF (HAX) into the Horizons AlphaPro S&P/TSX 60 Equal Weight Index ETF (HEW). Is it doing any better than the weak performance of HAX?

We look at these questions while comparing all the ETFs' total return performance and examining what caused the returns to differ. There are six large cap equity ETFs to consider:

Total Return Performance

First, we note that the true performance of these ETFs, as with any investment, is the total return composed both of capital appreciation and dividends/distributions. The Globe's John Heinzl explains what total return is and why it matters in a short video here. A second note is that ETF performance is evaluated based on Net Asset Value or NAV, which is the sum of the values of all the holdings within the ETF, as opposed to the actual market price of the ETF, which bounces up and down slightly above and below (the slighter the better) the NAV. Investopedia explains a bit more here. shows the monthly variation price above NAV (premium) vs below (discount) in its ETF quotes e.g. for XIU here.

In our comparison table below, we see that the return winner is clearly CRQ – Claymore Canadian Fundamental Index ETF for its significantly superior returns (green numbers) over all but one timescale (except year-to-date up to Feb.29th 2012). Claymore's website promotional material (e.g. it's Better way to invest paper) claims that its fundamental weighting indexing method is a "better mousetrap" that will outperform. Maybe there is some truth to the assertion, though even five years is not a sufficiently long time to reach any firm conclusions. A big surprise is that CRQ's considerably higher MER fee of 0.71% has not knocked its returns below those of other ETFs with much lower fees. It defies a good investing rule of thumb that a lower fee, especially when it comes to autopilot index funds, leaves the investor better off.

HXT seems to be successful so far in carrying out its announced mandate to provide the investor with the TSX 60's return net of its fees. Its returns have indeed been the amount of its 0.07% annual fees below the TSX 60 returns.

What's inside - financial services, consumer staples, materials, telecommunications - makes the difference - Our next table below shows the internal composition of the ETFs that have made a difference in performance and will continue to do so. The dark purple numbers in the CRQ column indicate the industry sectors where there is a substantial divergence between CRQ and the standard benchmark TSX60 index and the ETFs that align deliberately (XIU, HXT) or in fact (ZCN, VCE) with it. CRQ contains a much heavier weighting in financial services and consumer staples and a much lighter weighting in materials and telecommunications. This has been the case for some years. As the Canadian banks have regained some market favour after losing it during the financial crisis, CRQ has benefited more than the other ETFs.

A few companies are key differentiators - Some very large companies that are either absent entirely from, or with vastly different weighting within, the various ETFs are the key driver of performance variation - notably Fairfax Financial, Manulife, Power Financial, Onex, Great West, RIM, Manulife, Sun Life, BMO, Barrick Gold, Canadian Natural Resources, Potash Corp, Goldcorp, BCE, Telus and SXC Health Solutions. See our recent Market Darlings and Dogs post for more detail.

Weightings moving closer - The weightings amongst all the funds but HEW have moved much closer together in the last few years. The little up ↑or down ↓arrows beside the industry sectors shows whether each weighting has moved up or down since our last review. The biggest sector, financial services, has gone up in XIU and ZCN and down in CRQ, bringing them much closer together. Materials, or mining, is now the biggest difference and will be a big driver of future return differences.

Performance doesn't necessarily attract investor money - Investors must not have noticed CRQ's performance, or perhaps they believe it cannot be sustained, since its asset base has remained stagnant. Meanwhile the much more recent start-up ZCN has leaped upwards in assets, attracting as much investor money in the 18 months since September 2010 as the entire size of CRQ.

VCE, ZCN and XIU/HXT are peas in a pod - The fact the new entrant VCE very closely mimics the TSX60 and therefore XIU and HXT as well as ZCN in its asset allocation among sectors and top holdings means that its future performance should follow closely too. VCE has garnered a reasonable $45 million in assets in the few months since its November inception. The very low 0.09% annual fee makes it a solid choice.

HEW will see its returns diverge - HEW's similar performance to the TSX 60 in the one year for which data is available should not be expected to continue. In the long term, the drastically different weighting amongst sectors and companies should cause its performance to diverge from the others. However, the tiny $8 million asset base of HEW is really not viable in the long term however so unless Horizons manages to catch investor attention, it may not be around for many years.

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.

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