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FundGrade A+® Award ETF contenders for 2023

Published on 09-14-2023

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Rules-based and active ETFs make their mark


Exchange-traded funds (ETFs) were originally created as passive investments. They offered investors a simple, low-cost way of index investing. In fact, the first viable ETF was introduced in Canada in 1990, and it tracked what was then known as the TSE 35 Index. As the number of ETFs in the Canadian market expanded, so did the availability of rules-based and actively-managed ETFs, departing from a strictly index-tracking approach. Some of these funds have delivered consistently good risk-adjusted returns over the past year, and have become contenders for the 2023 Fundata FundGrade A+® Awards.

As the name implies, rules-based ETFs use prescribed rules to make investment decisions. A simple example would be an equal-weighted ETF such as iShares Equal Weight Banc & LifeCo ETF (TSX: CEW), which allocates an equal percentage of the fund to the 10 largest Canadian banks and life insurance companies and is rebalanced quarterly.

On the other hand, active ETFs give portfolio managers slightly more flexibility. They still have investment objectives and strategies that they must adhere to, but the investment decisions do not necessarily follow a set of rules. Ultimately the portfolio managers are responsible for making investment decisions.

Now, two thirds of the way through 2023, let’s look at a couple of rules-based and active ETFs that are vying for their first ever Fundata FundGrade A+ Award.

TD Q U.S. Small-Mid-Cap Equity ETF (TSX: TQSM) (89205) is a rules-based ETF that debuted in November 2019 and has become a top performer in the US Small/Mid Cap Equity category. The portfolio managers at TD Asset Management use a quantitative approach to security selection aimed at exploiting market inefficiencies based on pricing and valuation. The portfolio is diversified across all sectors and currently includes over 183 individual securities.

TQSM has a management expense ratio (MER) of 0.45%, which includes a management fee of 0.4%. Add to this a trading expense ratio (TER) of just 0.01%, for a total cost of just 0.46%. But despite the fund’s solid performance and relatively low fund expenses, trading has historically been thin for this ETF. Based on the most recent ETF Facts, average daily volume was just 1,980 units, and the bid/ask spread was 0.29% for the 12 months ending Aug. 31, 2023. Recently, however, trading metrics have improved significantly, with an average daily volume of over 15,000 units year to date. Investors are taking notice.

In its short history, TQSM has produced superior returns with lower volatility compared with the market and its peers. Year to date the fund is up 11%, outpacing the category average of 6.7%. Over the past three years the performance has been equally impressive. While its 3-year average annual compounded return of 15% ranks fourth out of 39 funds in the category, it also boasts the lowest standard deviation over this period at 12.6%. This outstanding risk-adjusted performance is the reason why TQSM is in line for its first FundGrade A+ Award in 2023.

Dynamic Active Investment Grade Floating Rate ETF (TSX: DXV) (79948) is also looking for its first FundGrade A+ Award in 2023. Debuting in March 2018 and listed in the Canadian Short Term Fixed Income category, the fund is managed by 1832 Asset Management. It is actively managed and invests primarily in Canadian investment grade credit and uses interest rate derivatives. The fund’s objective is to provide floating rate income while preserving capital and limiting interest rate risk.

DXV has a forward yield of 5.6% and a trailing 12-month yield of 6.1%. The fund is concentrated, holding only 40 securities. The duration is just 0.34 years, meaning interest rate risk is low. The MER, including a management fee of 0.3%, is 0.33%, while the trading expense ration (TER) is 0.01%. Trade data based on the most recent ETF Facts shows an average daily volume of over 35,000 units and an average bid/ask spread of 0.16%.

Over the past few years, the relative performance of DVX has improved significantly. Five years ago, it ranked 62 out of 73 funds. Three years ago, it moved up to 13 out of 80. And over the past 12 months, while many funds earned less than 1% and some actually lost money, DVX was the second best performing fund with a return of 5.8%.

True to its objective, the fund has also been able to limit volatility. Over the past three years it had a standard deviation of just 1.2%, half the category average. Suffice it to say this fund has successfully navigated the rising interest rate environment and has thrived when many passive fixed income funds have stumbled.

Winners of the FundGrade A+ Awards for 2023 will be announced in January 2024.

Brian Bridger, CFA, FRM, is Senior Vice President, Analytics & Data, at Fundata Canada Inc. and is a member of the Canadian Investment Funds Standards Committee.

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.

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