The landscape for Canadian exchange-traded funds (ETFs) is changing rapidly. New ETFs are coming to market regularly, offering an increasing number of investment strategies. But as with any popular new product, it pays to take a moment to understand exactly what you’re investing in. The new “actively-managed” ETFs, particularly, can be complex and not necessarily track an index the way more traditional ETFs do.
Significantly, ETF assets under management are growing as new money floods into new ETFs, attracted by their low MERs, wide investment choice, and ready tradeability. A study from McKinsey & Company states “total global ETF AUM could grow from approximately $1.5 trillion today to between $3.1 trillion and $4.7 trillion over the next five years”. Interest in the ETF business has spawned an industry organization (Canadian ETF Association) as well as magazines (Canadian ETF Watch, published by Radius Financial Education), books, and conferences. Brokers, too, have been vying for a piece of the lucrative ETF trading business, with some discount firms even offering commission-free ETF trading promotions.
The large majority of Canadian ETFs are straightforward index-tracking funds, a strategy that about 90% of ETF use. The other 10% are actively managed, but the scale should balance out in coming years as actively managed ETFs grow in popularity as an alternative to mutual funds.
Previously I covered two actively-managed ETFs from Horizons: Horizons AlphaPro Seasonal Rotation ETF (TSX: HAC) for its unique investment strategy, and Horizons North American Growth ETF (TSX: HAW) for its top performance. This round, I’ll look at two of the better-performing ETFs from iShares.
iShares Diversified Monthly Income Fund (TSX: XTR) is currently a Fundata FundGrade® "A" Grade™ performer and received an FundGrade A+ Rating™ in 2011 for its consistently high performance in the Canadian Equity Balanced category. The 3-year return of 21.1% ranks second in the group, behind only Norrep Income Growth Class at 26.8%. The fund posted a calendar return in 2011 of 6.4%, good for third-best in the group.
iShares ETFs are managed by BlackRock Asset Management Canada, and in this case they invest entirely in other iShares ETFs. The primary objective of the ETF is “to provide a consistent monthly cash distribution, with the potential for modest long-term capital growth.” The underlying ETFs are a mix of index-tracking equity and fixed-income funds with the current mix yielding Canadian corporate bonds, Canadian equity, and foreign bonds as the top three asset classes. The prospectus clearly states that the management team “will review, and may adjust, XTR’s strategic asset allocation from time to time, as market conditions change.” “Diversified” is in the name of the fund for a reason: When you look at the constituent funds of the nine underlying ETFs, you end up with a total of 1,822 securities.
An example of a unique strategy from the BlackRock team is employed in the iShares Equal Weight Banc & Lifeco Fund (TSX: CEW). This is more of a passively managed fund, because while it does not track an index, the portfolio is rebalanced only twice per year,.
The management team invests equally in the largest Canadian banks and insurance companies with minimum market-cap requirements at $5 billion for the banks and $1.5 billion for the insurance companies. As of May 30 there were 10 holdings – all six major Canadian banks and the four insurance companies: Sun Life Financial Inc. (TSX: SLF), Great-West Lifeco Inc. (TSX: GWO), Manulife Financial Corp. (TSX: MFC), and Industrial Alliance Insurance and Financial Services Inc. (TSX: IAG).
The mix of banks and insurance companies lands this ETF in the Financial Services Equity category, and it has been fairly profitable so far. The 3-year compound return is 13.7%, ranking it second in the group and above the 8% average return. Similar to the iShares Diversified Monthly Income Fund, this ETF pays a monthly distribution.
As the total number of Canadian ETFs continues to grow, so does the variety in investment strategies, and some strategies can be more complex than others. So to get a good understanding of the risks involved, it’s important to read and understand the investment strategies an ETF uses before you plunge in.
Reid Baker is a Senior Analyst in the department of Investment Analytics and Research at Fundata Canada Inc., a leading source for investment fund information, and is Chairman of the Canadian Investment Funds Standards Committee (CIFSC).
Notes and Disclaimers
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Commissions, trailing commissions, management fees and expenses all may be associated with mutual fund investments. Please read the simplified prospectus before investing. Mutual funds are not guaranteed and are not covered by the Canada Deposit Insurance Corporation or by any other government deposit insurer. There can be no assurances that the fund will be able to maintain its net asset value per security at a constant amount or that the full amount of your investment in the fund will be returned to you. Fund values change frequently and past performance may not be repeated. The foregoing is for general information purposes only and is the opinion of the writer. No guarantee of performance is made or implied. This information is not intended to provide specific personalized advice including, without limitation, investment, financial, legal, accounting or tax advice.