December 23rd, 2008
Investing
in Exchange Traded Funds (ETFs):
DIAMONDs, SPDRs, Qubes, HOLDRs, VIPERs, iShares
They are simple and
valuable investments with strange sounding names! Exchange Traded Funds (ETFs)
essentially are mutual funds that trade like a stock. They are baskets of
securities held in a trust (just like mutual funds) and can be traded as a
listed security on a stock exchange (just like a stock).
Differences
between mutual funds and ETFs
·
Securities held
in most mutual funds are actively managed. Securities held in ETFs track an index established by a stock exchange.
Selection of securities is predetermined (i.e. passively managed). Accordingly,
the cost of managing Exchange Traded Funds and their corresponding Management
Expense Ratios (MERs) are significantly less than
mutual funds.
·
Mutual funds are
priced once a day based on their net asset value at the end of the trading day.
ETFs are priced in the market during the
trading day based on their tracking value of the index that they represent.
·
Mutual funds hold
securities that are actively bought and sold during the year by managers who
are using their expertise and experience to improve portfolio returns. ETFs, by definition, hold securities that are
infrequently changed, and therefore tend to have lower capital gains
distributions at the end of the year.
Differences
between listed securities and ETFs
·
Buying a
diversified portfolio of individual securities, that approximately represents
the market, can be time consuming and expensive. In contrast, buying an ETF,
that holds a diversified portfolio of securities representing the market, can
be completed easily in one trade.
·
Transaction
costs normally are lower for ETFs than for individual
securities (particularly on broadly
based ETFs) because bid/ask spreads for ETFs frequently are less.
Why
the strange sounding names?
The names frequently are an acronym for an
Exchange Traded Fund:
·
SPDRs (also called SPDRS):
Standard & Poor’s 500 index Deposit Receipts
·
DIAMONDS: Dow Jones Industrial Average
tracking unit.
·
VIPERS: Vanguard Index Participation Equity
Receipts
·
Qubes: based on symbol for the NASDAQ 100 tracking units: QQQQ.
·
HOLDRs: Holding Company Depositary Receipts
An
Example using SPDRs
SPDRs are an Exchange Traded Fund that tracks the S&P
500 Index. SPDRs trade approximately at 1/10th
the value of the Index. If the S&P 500 Index is trading at 900, SPDRs (Symbol: SPY) will trade at almost exactly $90 per
unit. The cost of 100 units will be $90 x 100 = $9,000
Types
of Indices Tracked by ETFs
Six types are available:
·
ETFs on broadly based indices (e.g. S&P 500 Index, Dow
Jones Industrial Average, S&P/TSX 60 Index)
·
ETFs on sector indices (e.g. health care, high tech,
financial services)
·
ETFs on style indices (e.g. growth, value, small cap,
medium cap)
·
ETFs on indices of countries or regions outside of
·
ETFs on bond indices.
·
ETFs on commodities and currencies
·
Leveraged,
inverse and inverse leveraged ETFs
Currently, 385
Reasons
to own ETFs
·
Easy to
understand and to follow. The media
frequently comments on events that influence the performance of broadly based
indices such as the S&P 500 Index, the Dow Jones Industrial Average and the
S&P/TSX 60 Index. Their comments also apply to performance of ETFs that track broadly based indices.
·
A convenient
way to build a diversified portfolio. Each
ETF owns a basket of securities. For example, iUnits
in the S&P/TSX 60 Index holds a diversified portfolio of
·
A low
Management Expense Ratio (MER) relative to actively managed investments. The average MER on a broadly based Canadian or
·
More tax
efficient than actively managed investments. Capital gains distributions at year-end from
·
Easily bought
and sold (particularly ETFs on broadly based indices). SPDRs were the most
actively traded equity security in the world in 2007 based on value of trading.
Qubes were the most actively traded security in the
world in 2007 based on the number of shares that traded. Volumes in both ETFs rose in 2007. Average daily volume in i60s,
Standard and Poor’s recently issued its
Canadian “Standard & Poor’s Indices
Versus Active Funds Scorecard” (SPIVA) report for the period ending September 2008. Link to the report is http://www2.standardandpoors.com/spf/pdf/index/SPIVA_Canada_3Q2008.pdf
The report once again confirms that most of
Standard and Poor’s uses the following S&P indices as their
benchmarks:
Category Comparison Index
Canadian Equity S&P/TSX Composite Index Total Return
Cdn. Small/Mid Cap Equity S&P/TSX Canadian Completion Total Return
Cdn. Dividend & Income Eq. S&P Cdn. Dividend Aristocrats Index Total Return
International Equity S&P/Citigroup EPAC PMI Index Total Return C$
Global Equity S&P/Citigroup World PMI Index Total Return C$
Results of the study revealed the following:
Percent of Active Funds Outperforming Benchmark
Index
Category One Year Three Years Five Years
Canadian Equity 23.44 8.54 7.14
Cdn. Small/Mid Cap Equity 29.31 N/A N/A
Cdn. Dividend & Income Eq. 79.41 21.21 3.70
International Equity 29.79 16.67 12.07
Global Equity 28.45 20.00 12.02
The cost of buying and
selling ETFs
Investors can choose between buying and selling ETFs in a transaction-based account or in a fee-based
account. Costs in a transaction-based
account will be the regular commission charged by your broker for completing an
equity trade. Costs in a fee-based account in most cases will be zero for the
transaction, but a fee based on the value of the portfolio will be assessed
periodically. Investors, who make most of their own investment decisions,
probably will prefer a transaction-based account. Investors, who rely on their
broker to offer investment advice on a continuing basis, may prefer to complete
transactions through a fee-based account. A fee of 1.5% per year for an equity
account valued between $100,000 and $500,000 is approximately “the going rate”
by Canadian investment dealers.
Other features of ETFs
The following information was obtained from publicly
available web sites:
·
ETFs listed on the Toronto Exchange are 100% eligible as
Canadian content in tax deferred accounts (e.g. RRSPs
and RRIFs).
·
Most ETFs pay a quarterly dividend.
·
Dividends paid by
ETFs with Canadian equity content listed on the
Toronto Exchange are eligible for the Dividend Tax Credit.
·
Trading hours
correspond with the regular trading hours of the Toronto Exchange and
·
All ETFs have redemption features. Holders with large positions
in ETFs are allowed to exchange their units for
shares that underlie the unit. Net result: units consistently trade at or near
their net asset value.
·
Many ETFs have listed options and Long term Equity APpreciation Securities (LEAPS). A list of optionable ETFs is provided at
the end of this report.
·
Dividend
re-investment (DRIP) programs on broadly based ETFs
are available through selected brokers.
·
ETFs are marginable.
·
ETFs can be shorted.
·
ETFs are sponsored
by well-known financial institutions.
Portfolio Strategies
Core and satellite investing
One of the more popular strategies! Investors place a
large portion (i.e. the core) of their equity portfolio into Exchange Traded
Funds. This portion acts as the anchor for the portfolio, ensuring that
portfolio performance will approximate stock market returns. Size of the core
depends upon the amount of stock market risk that the investor is willing to
assume. Investors, who are satisfied with realization of returns that
approximate “the market”, will place a larger portion of their portfolio into ETFs (say 40%-80%). Investors, who are willing to take more
risk in order to improve prospects for “outperforming
the market”, will place a smaller portion into ETFs.
The remainder of the portfolio is invested into “special situations” with the
potential to outperform the market. Choices include attractive equities,
specialty mutual funds, sector ETFs, hedge funds,
etc.
Portfolio Rebalancing
ETF positions can be adjusted easily when equity,
fixed income and cash weights in a portfolio need to be rebalanced due to
changing market conditions. With one trade in an ETF of a broadly based index,
equity positions can be increased or reduced.
Sector Investing
Investors can choose, when timely, to over weight
sectors that have better potential. Investors can choose between six Canadian
sector ETFs and over 60
Seasonal Trend Investing
North American, European and Japanese equity markets
tend to be strongest from the end of October to the end of March /April.
Investors can take advantage by owning broadly based ETFs
during the period of seasonal strength and by switching into treasury bills
during the remainder of the year.
Sectors in equity markets also have seasonality and
can be traded accordingly. See the Special Report section at www.timingthemarket.ca for background.
Risks
By definition, an investor holding an Exchange Traded
Fund will never outperform the market. The investor will track the market (less
a small MER).
Some ETFs have a high percent
of their portfolio invested either in a sector or an individual security.
Concentrations can influence the volatility and performance of the ETF.
A small number of ETFs hold
a basket of securities that are known to be volatile. Most of these hold high
tech securities with a history of significant price swings.
Monitoring ETFs through the Internet
The following web sites are useful for investors who
are looking for more information about ETFs:
Sites for a quick overview and description of ETFs that trade on
ETF content and weights:
IShares
iShares Canadian information: www.ishares.ca
Select sector SPDRs
information: www.spdrindex.com
StreetTracks ETF information: www.streettracks.com
Merrill Lynch HOLDRs
information: www.holdrs.com
Vanguard ETF information: www.vipers.vanguard.com/etf
PowerShares ETF information: www.powershares.com
FT Portfolios ETF information: www.ftportfolios.com
Proshares ETF information: www.proshares.com
Rydex Funds ETF information: www.rydexfunds.com
Wisdomtree ETF information: www.wisdomtree.com
Claymore Investments ETF information: www.claymoreinvestments.ca
XShares ETF information: www.xshares.com
ETF information: www.exchangetradedfunds.com
Index providers:
S&P indices: www.standardandpoors.com
Dow Jones indices: www.djindexes.com
MSCI International indices: www.msci.com
Russell indices: www.russell.com
Wilshire indices: www.wilshire.com
FTSE
group indices: www.ftse.com
Index universe: www.indexuniverse.com
ETF Information and opinion sources
Exchange Traded Fund List
Equity Index Units Traded in
Name SymbolMER Opt. Volume
(%) Daily
3 months
Nov.2008
(000)
IShares S&P/TSX 60 Index XIU 0.17 yes 15,000
IShares Composite
Cdn. Eq Capped Index XIC 0.25 no
200
IShares
S&P 500 C$ Index Fund XSP 0.25 no
300
IShares
International C$ Index Fund XIN 0.50 no
200
iSharesDividend Index XDV 0.50 no
100
IShares
S&P/TSX Canadian Capped Energy Index XEG 0.55 yes 1,500
ISharesS&P/TSX Canadian Capped Financial Index XFN 0.55 yes 1,000
ISharesS&P/TSX Canadian Capped Gold Index XGD 0.55 yes 1,000
iShares Income Trust Sector Index XTR 0.55 no 150
IShares S&P/TSX Canadian Capped Info.Tech. XIT 0.55 yes 50
iSharesMaterials Sector Index XMA 0.55 yes 250
IShares
S&P/TSX Canadian Capped Midcap Index XMD 0.55 no
50
ISharesS&P/TSX Canadian Capped REIT Index XRE 0.55 no
200
iShares Cdn. Value Index Fund XCV 0.50 no
10
iShares Cdn. Growth Index Fund XCG 0.50 no
10
iShares Cdn. Janzi
Social Index Fund XEN 0.50 no
5
iShares Cdn. Small Cap Index Fund XCS 0.55 no
20
iShares Cdn. Russell 2000 Index
Fund XSU 0.35 no
10
iShares Alternate Completion Portfolio Builders XAL 0.70 no N/A
iShares Conservative Core Portfolio Builders XCR 0.60 no
N/A
iShares Global Completion Portfolio Builders XGC 0.70 no
N/A
iShares Growth Core Portfolio Builders XGR 0.60 no N/A
Merrill
Lynch CP HOLDRS HCH * no
2
Claymore FTSE RAFI Canadian Index Fund CRQ 0.65 no
30
Claymore Cdn Dividend and
Income Achievers CDZ 0.60 no
10
Claymore U.S. Fundamental Index (C$ hedged) CLU 0.65 no 25
Claymore Oil Sands sector CLO 0.60 no
15
Claymore BRIC CBQ 0.60 no 50
Claymore International Fundamental CIE 0.65 no
10
Claymore Preferred Shares CPD 0.45 no
25
Claymore
Claymore Global Water CWW 0.60 no 15
Claymore Global Mining CMW 0.55 no
10
Claymore Global Balanced Income CBD 0.70 no 2
Claymore Global Balanced Growth CBN 0.70 no 2
Claymore Global Agriculture COW 0.65 yes
100
Claymore Global Monthly Yield Hog CYH 0.65 no 8
Claymore Cdn. Financial
Services CEW 0.65 no
10
Claymore Global Real Estate CGR 0.65 no
N/A
Claymore Global Infrastructure CIF 0.65 no
10
Claymore
Claymore Financial Monthly Income FIE 1,00 no 50
Horizon BetaPro 60 Bull + HXU 1.15 no 4,000
Horizon BetaPro 60 Bear + HXD 1.15 no 3,000
Horizon BetaPro Financial
Bull + HFU 1.15 no
500
Horizon BetaPro Financial
Bear + HFD 1.15 no
300
Horizon BetaPro Energy Bull
+ HEU 1.15 no 2,000
Horizon BetaPro Energy Bear
+ HED 1.15 no
500
Horizon BetaPro Gold Bull + HGU 1.15 no 5,000
Horizon BetaPro Gold Bear + HGD 1.15 no 1,500
Horizon BetaPro Crude Oil
Bull+ HOU 1.15 no 1,000
Horizon BetaPro Crude Oil
Bear + HOD 1.15 no 1,000
Horizon BetaPro Natural Gas
Bull+ HNU 1.15 no 1,000
Horizon BetaPro Natural Gas
Bear + HND 1.15 no
250
Horizon BetaPro Comex Gold Bullion Bull+ HBU 1.15 yes
400
Horizon BetaPro Comex Gold Bullion Bear + HBD 1.15 yes
100
Horizon BetaPro S&P/TSX
Global Mining Bull + HMU 1.15 no
100
Horizon BetaPro S&P/TSX
Global Mining Bear + HMD 1.15 no
50
Horizon BetaPro Agriculture
Bull + HAU 1.15 no
50
Horizon BetaPro Agriculture
Bear + HAD 1.15 no
2
Horizon BetaPro S&P 500
Bull + HSU 1.15 no
500
Horizon BetaPro S&P 500
Bear + HSD 1.15 no
300
Horizon BetaPro NASDAQ 100
Bull + HQU 1.15 no
100
Horizon BetaPro NASDAQ 100
Bear + HQD 1.15 no 200
Horizon BetaPro U.S. Dollar
Bull + HDU 1.15 no
10
Horizon BetaPro U.S. Dollar Bear
+ HDD 1.15 no
50
Horizon BetaPro 30 Year Bond
Bull + HTU 1.15 no
2
Horizon BetaPro 30 Year Bond
Bear + HTD 1.15 no
20
Horizon BetaPro MSCI
Emerging Markets Bull + HJU 1.15 no
200
Horizon BetaPro MSCI
Emerging Markets Bear + HJD 1.15 no
50
Equity Index Units Traded in the
Major Market ETFs SymbolMER Opt. Volume
(%)
Daily
3 months
(000)
Broad
Market Nov.2008
Total
Stock Market VIPERs VTI 0.07 yes 5181
IShares
Russell 3000 IWV 0.20 yes 1027
IShares DJ
US Total Market IYY 0.20 yes 172
IShares S&P 1500 ISI 0.20 no
102
Fidelity NASDAQ Composite Tracking Stock ONEQ 0.30 yes
300
Extended
Market VIPERs VXF 0.08 yes
314
StreetTRACKS
Total Market TMW 0.20 yes
27
FTSE
RAFI
Dynamic MagniQuant PIQ 0.60 no
18
Large-Cap
Diamond
Trust Series 1 DIA 0.18 yes 33,417
NASDAQ
100 Index Tracking Stock QQQQ0.20 yes
238,164
IShares
S&P 100 OEF 0.20 yes 3,017
IShares
S&P 500 IVV 0.09 yes 6,971
IShares
NYSE 100 NY 0.20 yes
22
IShares
NYSE Composite NYC 0.25 no 24
Standard
and Poors Depository Receipts SPY 0.10 yes
385,021
IShares
Russell 1000 IWB 0.15 yes 2,322
Rydex
S&P Equalweight RSP 0.40 yes
646
Large
Cap VIPERS
VV 0.07 yes 714
Morningstar
Large Core JKD 0.20 no
35
StreetTRACKS
DJ Wilshire Large Cap ELR 0.20 no
5
First
Trust NASDAQ 100 Equal Weight QQEW0.60 no 20
Rydex
Russell Top 50 XLG 0.20 no
226
Dynamic
Large Cap PJF 0.60 no
33
First Trust Large Cap Core AlphaDEX FEX 0.70 no 5
Vanguard Mega Cap 300 MGC 0.13 no
168
RevenueShares Large Cap RWL 0.49 no
29
PowerShares NASDAQ Next Q Portfolio PNXQ 0.70 no 3
Wisdom Tree Large Cap Growth ROI
Mid-Cap
IShares
S&P MidCap 400 IJH 0.20 yes
1,182
S&P Midcap 400 Depository Receipts MDY 0.25 yes
9,462
IShares
Russell Midcap IWR 0.20 yes
1,270
Mid-Cap
VIPERS VO 0.13 yes
568
Morningstar
MidCore JKG 0.25 no
26
StreetTRACKS DJ Wilshire Mid Cap EMM 0.25 no
15
Dynamic Mid-Cap PJG 0.60 no
16
First Trust Mid Cap Core AlphaDEX FNX 0.70 no
7
RevenueShares Mid Cap RWK 0.54 no
16
Small
Cap
IShares
S&P Small Cap 600 IJR 0.20 yes 2,810
IShares
Russell 2000 IWM 0.20 yes 119,778
Small-cap
VIPERS VB 0.10 yes 327
Morningstar SmallCore JKJ 0.25 no 28
iShares Microcap IWC 0.60 yes
175
StreetTRACKS DJ Wilshire Small Cap DSC 0.25 no
9
First Trust MicroCap FDM 0.60 yes 8
Zacks Small Cap PZJ 0.60 yes
14
Zacks Micro Cap PZI 0.60 no
47
FTSE RAFI Small – Mid PRFZ 0.60 no
94
FT Dow Jones Select Microcap FDM 0.60 yes 8
Dynamic Small Cap PJM 0.60 no
11
First Trust Small Cap Core AlphaDEX FYX 0.70 no
9
RevenueShares Small Cap RWJ 0.54 no 11
PowerShares FTSE Small Cap Portfolio PQSC 0.70 no 5
Style ETFs
Broad
Market Growth
IShares
Russell 3000 Growth IWZ 0.25 no
177
First
Trust Growth FPX 0.60 no
12
Broad
Market Value
IShares Russell 3000 Value IWW 0.25 no
97
First Trust Equity Income FDL 0.60 no
28
First Trust Multi Cap Growth AlphaDEX FAD 0.70 no
6
First Trust Multi Cap Value AlphaDEX FAB 0.70 no
6
Large-Cap
Growth
IShares S&P 500/Barra Growth IVW 0.18 yes 2,414
IShares
Russell 1000 Growth IWD 0.20 yes 3,465
StreetTRACKS
DJ Wilshire Large Cap Growth ELG 0.20 no
51
Growth VIPERS VUG 0.15 yes