A taste of the classics

05-21-2020
A taste of the classics

Passive index ETFs a place to test the waters?

Broad, passive exchange-traded funds are the real granddaddies of the ETF universe, with a mandate that sticks to the original theory behind ETFs. They are usually designed to passively track a broad, well-known market index, providing a simple, low-cost way to buy an entire market, with all the benefits of diversification that entails.

During the March market meltdown triggered by the Covid-19 pandemic, the broad stock market ETFs did just that, sinking precipitously along with their underlying index. But since then, there’s been something of a recovery, though it’s anyone’s guess whether it’s sustainable or whether the indexes will re-test their March lows again in the near future. Still, for those who might want to test the waters with a diversified portfolio, always mindful of that dangerous undertow, some of the broad indexes might be a place to start.

Personally, I like to stick with the main indexes from the bigger providers like S&P, MSCI, or FTSE. I may consider some of the other providers where there is a real advantage to do so, but mostly I like the big names. Here’s a list of some of my favourites.

Vanguard Canadian Short-Term Bond Index ETF (TSX: VSB) – This is my top pick for broad-based short-term bond exposure. Despite carrying an MER that is 1 basis point higher than the iShares version (XSB), I prefer it for its higher credit quality and greater exposure to government bonds. I have always viewed short-term fixed income as a safe haven, and with my expectation of higher equity-market volatility in the next few months, I believe this offering will hold up slightly better than XSB.

iShares Core Canadian Universe Bond Index ETF (TSX: XBB) – Designed to track the FTSE Canadian Universe Bond Index, this ETF is my top pick for broad-based Canadian fixed income exposure. It provides exposure to the largest government and corporate bonds in Canada and has provided a modest level of outperformance to its peers, the BMO Aggregate Bond ETF (TSX: ZAG) and the Vanguard Canadian Aggregate Bond Index ETF (TSX: VAB).

The portfolio has a bit more exposure to corporate bonds than VAB, which offers a slightly higher yield and a slightly lower interest rate sensitivity. Costs are roughly in line, although VAB and ZAG are a basis point cheaper. Still, I currently favour XBB as my top core bond holding.

Vanguard S&P 500 ETF (TSX: VFV) – This is designed to track the S&P 500 Index. It is also available in a fully currency-hedged version (TSX: VSP). I am currently favouring the unhedged VFV because I expect volatility to increase. Historically, when volatility increases, the U.S. dollar has strengthened on a flight-to-safety trade. When that happens, the losses for those with unhedged exposure are reduced, helping protect capital better. I favour this Vanguard offering over the iShares version (XSP or XUX) because of its lower cost – 8 basis points compared with 11 bps for XUS.

BMO MSCI EAFE Index (C$ Hedged) (TSX: ZDM) – The pickings for international and global ETF offerings are significantly lower than what is available for Canadian and U.S. ETFs. That makes finding a good solution a bit more difficult. Another challenge with the international and global offerings is that they tend to come at a higher cost than Canadian and U.S. versions, making them much less attractive to using actively managed mutual fund offerings. But if you’re looking for low-cost, passive international equity exposure, this BMO offering would be my pick. It offers exposure to the broadly diversified MSCI EAFE Index, has outperformed other passive EAFE options, and does so at a cost of 22 basis points.

Dave Paterson, CFA, is a money manager and an expert on investment fund research and due diligence on a variety of investment products.

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