I’m not sure if I’ve ever told you guys about my favorite ETF, but I guess there’s no time like the present, huh?
There’s later. That’s a time.
You don’t show up for months and that’s what you give us? Thanks for nothing, Italics Man.
There are some really dumb ETFs out there. I’ve profiled at least one over the years, which was just a high-interest savings account that paid out a very small monthly distribution. I also looked at a stock buyback ETF that did a pretty poor job of actually picking stocks that repurchase shares.
But my absolute favorite sector ETF is the BMO Equal Weights Bank ETF (TSX:ZEB), which charges you (yes, you specifically) a 0.62% management fee to hold equal positions in six different bank stocks (the big five everyone has heard of and National Bank). That’s it. That’s the whole ETF. What a scam.
Reminder: your ETF fees really add up over time.
The Equal Weights Bank ETF is the worst example of the problem, but there are sector ETFs out there that are barely better. Investors buy them for instant diversification without realizing they’re dominated by a handful of names. And the management fees are damn high, especially for what you get.
Let’s take a look at a few of the worst offenders.
The worst sector ETFs
You’d think it would be the financial sector, but not really. It turns out there are a lot of insurance companies and whatnot that get decent exposure.
Let’s start with the largest utility ETF, the iShares S&P TSX Capped Utilities Index (TSX:XUT). It has 16 different holdings and will set you back 0.61% each year. Get used to that number; you’re going to see it a lot.
The top five weightings are 65% of the fund, and the top three are 50% of the ETF. That seems like a little much to me, but maybe that’s just my active investor bias talking.
The iShares S&P TSX Capped Consumer Staples ETF (TSX:XST) has a management fee of 0.61% and has a grand total of ten different holdings. This is what you’re paying more than half a percent a year for. It’s the entire ETF.
Almost 81% of this ETF’s holdings are concentrated in the top five names. It could easily be more diversified, too. It doesn’t own High Liner Foods, Rogers Sugar, Molson Coors, Andrew Peller, or even Dollarama. Why? Damned if I know. But hey, way to buy both Loblaw and George Weston. The latter owns about half of Loblaw.
Before I feature the worst sector ETF of all, I do want to point out these aren’t big funds. Both the utilities and consumer staples ETFs are only flirting with $100 million in total assets. That makes them nothing burgers in the big world of finance. This next pick is bigger but with assets of $163 million it’s not exactly a powerhouse.
Coming in at a 0.61% MER it’s the iShares S&P TSX Capped Information Technology ETF (TSX:XIT). Oh baby. Are you ready?
That’s right, kids. A full 88.4% of this ETF’s assets are stuffed into the top five holdings. This is something you could very easily replicate on your own and avoid the hideous fee.
When are sector ETFs useful?
Not every sector ETF sucks. There are a few decent ones.
The REIT one (TSX:XRE) isn’t bad. It has 16 holdings without huge exposure to the top five companies. I’d still rather pick individual REITs and the TSX universe has about 50 different REITs to choose from, meaning it’s really not that diverse. It’s still a decent place to start for investors looking for a little real estate exposure.
The iShares Preferred Share ETF (TSX:CPD) is also a pretty solid choice for folks looking for a little income that isn’t really correlated to the overall stock market. Again, I’d rather pick individual preferred shares but it’s a decent hands-off option.
I also think there’s potential to use sector ETFs to bet on either the energy or material sectors recovering. I wouldn’t even touch those sectors with your Visa card but there are certainly worse ways to bet on a sector coming back into favor.
Let’s wrap it up, pup
I realize sector ETFs are specialty products that not many people own. That’s good. We don’t want large groups of investors to acquire these things.
I’d recommend somebody looking to overweight a sector to just pick the best names in that particular part of the market and build your own mini sector ETF. Most of the big ones in Canada concentrate on a few top holdings meaning it’s really easy for you to replicate one on your own.
Back in the day, when Italics Man was nothing but a glimmer of my imagination, I did a series of articles answering y’all’s DEEP PRESSING QUESTIONS about how to invest in certain emerging market countries with potential. Or I did it for the SEO. Both of these reasons are equally important.
Here are some of them. Feel free to LOL at the Turkey one, since that’s turned out to be a goddamned disaster.
One criticism I never got but a lot of you probably voiced silently in your heads was the risk of investing in a single emerging market. Russia and Turkey had crazy guy in charge risks, which will always make foreign investment in a country dangerous. Sure, you and I buying some random ETF aren’t really making a direct investment, but the result ends up the same if the crazy guy stops giving preferential treatment to foreigners doing business in a country.
Then there’s the additional risk of investors simultaneously hating all emerging market stocks, something that comes around every 5-10 years. All of a sudden investors wake up to the fact that nations like Brazil and China aren’t all sunshine, lollipops and blowjobs. This bearishness lasts anywhere from a few months to a year, then things recover, and everyone lives happily ever after again.
Let’s take a closer look at a couple of emerging market ETFs that I’m considering buying.
I sure am committing to this joke, huh?
Why does a guy with a dividend investing site need to buy an emerging markets ETF? Why not buy the stocks directly? Or buy Canadian stocks with emerging market exposure?
This is an actual great point, Italics Man. I still hate your face, though.
I don’t have a face, moron.
First off, I did buy a couple of stocks that have emerging markets exposure. They’re Bank of Nova Scotia (which has a bunch of assets in Central and South America) and Polaris Infrastructure, which owns a geothermal power plant in Nicaragua. I have a few others on my watchlist, too, like some of the airport operators. Airports are a fantastic business.
Most of the emerging markets stocks in Canada are gold miners or oil producers with assets in some far-flung nation. I try to avoid all resource stocks now, so buying them is out of the question. There are many more that trade on the NYSE, but it’s much more difficult to research these. I know the banking sector in Canada intimately. I couldn’t tell you much about the sector in Chile.
In short, it’s just easier to get my exposure via ETFs. And since most emerging markets have been whacked, I don’t have to pick individual ones. I can start nibbling at broad indexes covering vast portions of the earth.
Like the Vanguard FTSE Emerging Markets ETF (TSX:VEE), which is down nearly 4% in the last month and is only up a little more than 1% over the last year. It has a management expense ratio of just 0.23% and it pays a nice dividend of approximately 2%.
The bad news? It’s a China-heavy fund. Nearly 35% of assets are invested in China with an additional 14% invested in Taiwan. It’s almost like a single-country ETF in disguise.
The iShares Core MSCI Emerging Markets ETF (TSX:XEC) only has 28% China exposure, and Taiwan’s share of assets is 12%. It also has a decent portion of its assets invested in South Korea. It charges a slightly higher management fee (0.28%) and offers a dividend yield of approximately 1%.
The Fund I’d Choose
The main problem with most of these emerging markets ETFs is they’re cap weighted. This means they own most of the largest companies. These companies are mostly Chinese. Hence, we get a large amount of exposure to China.
The Schwab Fundamental Emerging Markets ETF (NYSE:FNDE) might be the best solution. It still has about 20% of its assets in China, which is a much more reasonable number. It pays a 2.8% trailing dividend and the portfolio as a whole seems to be pretty fairly valued. Morningstar says the portfolio trades at approximately 8x forward earnings and slightly under book value. Finally, it’s a large ETF with more than 300,000 shares trading hands daily. Those are the kinds of metrics I like to see.
The only real downfall? It trades in U.S. Dollars. There’s a cost to doing that conversion for Canadian investors.
I know the whole point of ETFs is to avoid the bias of picking certain stocks or countries, but China gives me ulcers. There is a lot of stuff to worry about. If China continues to show weakness, the Schwab fund should outperform its peers. And if China keeps on trucking, FNDE will still go along for the ride.
Hey, he’s back!
You guys are only excited because of incredibly low expectations, but I’ll take it.
Let’s talk a little about share buybacks. For those of you who don’t know what in the prey hell a share buyback is, it’s when a company takes extra money and uses it to buy its shares back in the open market.
A simple example. Say you had a $1 million company that’s divided into a million shares, each worth a dollar. It earns $100,000 one year, capital that doesn’t need to be reinvested in the business. So you decide to use the cash to buy back shares. Your company is still worth $1 million but there’s only 900,000 shares outstanding. So each share is now worth $1.11.
It’s easy to see why the holders of the remaining 900,000 shares are fans of this scenario. Their shares are worth more despite not doing a damn thing.
Many top companies regularly buyback shares, but they really half-ass it. Each year, management get a certain number of shares as bonuses, mostly just for existing. To mask that dilution, companies will buy back just enough shares so the total outstanding shares don’t go up.
Aside: Here’s what I’m talking about — enough with the joke share buybacks.
I recently discovered an ETF dedicated to share buybacks. The First Asset Canadian Buyback Index ETF (TSX:FBE) “provides investors with exposure to a portfolio of equity securities of quality companies with active share buyback programs that have significantly and consistently reduced their issued and outstanding share count.”
Does it deliver? Let’s take a closer look.
The terrible ETF
There’s a simple way to check whether this ETF delivers on its promises. We can look at the top 10 holdings and see what’s happened to the share count from the end of 2013 to 2016.
Let’s table this up, bitches.
||% Change in Share Count
|West Fraser Timber
|Brookfield Asset Mgmt
|Canadian National Railway
So, overall, that ain’t bad. A total of four out of ten increased their share counts in the preceding three years, but two did so only marginally. WE’RE ONTO YOU, ROGERS AND CAMECO.
The fund has 40 total holdings, but it doesn’t actually put the holdings online, so I needed to consult the latest fact sheet. It’s limited to the top 10.
Before writing this post the most recent fact sheet I could find was from September 30th. Here are the top 10 holdings back then. Try to stifle your laughter.
||% Change in Share Count
The holdings back in September decreased their total share count by less than 1% on average over the preceding three years. Encana did two major share issues in the preceding three years. The CEO of Constellation Software has gone on record and said he dislikes share buybacks.
These are the kinds of companies to be included in a share buyback ETF? Really?
Check under the hood
Before we give this ETF too much crap, keep in mind it follows the CIBC Canadian Buyback Index, which actually has a history of outperformance.
Still, you’d think the index would be built in a specific way. The companies with the largest share buybacks would be top positions, while the ones that don’t make any significant progress wouldn’t make the list.
But it isn’t set up that way. Aimia has repurchased 12% of its outstanding shares since 2013. Telus has bought back 5.4% of its shares. They don’t show up anywhere in the top 10 holdings. The top holdings are a mix of true share buyback superstars and companies who take the practice as seriously as I take my latest diet.
The lesson is to look under the hood of these specialty ETFs. Which takes away from the entire point of buying an ETF in the first place. You don’t buy ETFs to do research. If you do the work, you might as well just build your own portfolio.
Anyhoo, if you’re looking for companies that buyback their shares on a regular basis, you can probably do better than the First Asset Buyback ETF. Just too many swings and misses.
Let’s talk a little about investing with Investors Group, which is one of Canada’s largest wealth management companies. It has approximately $130 billion in assets under management, or about what I have hiding in the couch cushions for a rainy day.There are some 5,000 Investors Group
advisors sales people spread out across Canada.
The investing process starts with a financial plan, which goes over all parts of your finances from your mortgage to your insurance to your investments. The client is told the process is so their needs can be fulfilled in the best way possible. This is a lie. It’s a sales process, nothing more.
Recently, Investors Group has been in the news for a couple of main reasons. The first is the company’s opposition to Canada’s new mutual fund disclosure rules. Before, disclosure of fees in a percentage form was fine. These days, fees must be disclosed as an actual dollar figure.
The company also made headlines for announcing it was doing away with deferred sales charges. This meant investors who get out of Investors Group mutual funds before a certain time period (usually 5-7 years) don’t have to pay huge penalties any longer. Such generosity! The company also cut fees on many of its in-house mutual funds.
Investors Group is actually really excited about this. Veteran investors know you should never invest with Investors Group, but there are literally millions of Canadians who don’t know any better. This post is for you.
An apples to apples comparison
Let’s take a closer look at one of Investors Group’s largest funds to see just how serious the company is about cutting fees.
The largest IG mutual fund is the Investors Dividend Fund. Because this company likes making things complicated, there are about a million different slightly different iterations of the same damn fund.
After a little clicking around, I’ve come to the conclusion that you’d be most likely to be sold is the Series B. It no longer has a deferred sales charge and the prospectus breaks down what the advisor gets paid in great detail.
The fund has 88% of its assets in Canadian equities, with the remainder in bonds and cash. It has a total of 125 different positions, but 57% of assets are in the top 10 stocks. Top positions include:
- Royal Bank (8.4%)
- Scotiabank (8.1%)
- TransCanada (6.0%)
- CIBC (5.7%)
- Power Financial (5.6%)
- Bank of Montreal (5.5%)
The management fee? It was 2.48%, but the company SLASHED it, proving once and for all Investors Group cares about its investors. The new fee? It’s 2.38%.
OMG YOU GUYS I’D BETTER GET THE FAINTING COUCH.
In 2016, the fund paid a distribution of $0.77, giving it a yield of just over 3%.
Now let’s compare it to the largest Canadian dividend ETF, which is the iShares Dividend Select ETF (TSX:XDV). It has 100% of assets invested in Canadian stocks. The largest positions include:
- CIBC (8.2%)
- Agrium (7.6%)
- Royal Bank (5.8%)
- Bank of Montreal (5.7%)
- Scotiabank (5.0%)
59% of XDV’s assets are invested in the financial sector. The Investors Dividend Fund has 57% of its assets invested in financials. There’s a lot in common between the two funds, not just that. They’re not identical, but damn close.
XDV has a trailing yield of 3.7%, a full 20% higher than the Investors Dividend Fund.
Where XDV really shines is its management fee. Investors are paying 0.55% annually to own XDV. That’s a full 78% less than owning an equivalent product with Investors Group. (And 0.55% is a little expensive in the ETF world. You can find ETFs for less than 0.10%).
We could look at other fund categories, but it would yield similar results. If you invest with Investors Group, be prepared to pay a hell of a lot more for something that can easily be replicated with a cheaper ETF.
Just don’t invest with Investors Group
Investors Group does a great job of presenting themselves in a professional manner and the average advisor will instill a sense of confidence into a newbie investor.
But ultimately, that comes at a huge cost to the client. A 2% difference in fees will make a huge difference in your retirement.
The bottom line? You’re better off to choose a simple ETF portfolio on your own. You’ll save tens of thousands of dollars in fees (if not more!) if you don’t invest with Investors Group.
Now before anybody starts throwing the internet version of rotten tomatoes at me, let me backtrack from that title a little. I like robo-advisors for small-time investors who are just starting out.
My mother is the perfect example. She barely has time to think after going to work and then cooking me three dinners. DAMMIT MOM THOSE FIRST TWO WEREN’T GOOD ENOUGH.
(tips over plates and then makes her clean up the mess)
She has very little interest in money except spending it to go on vacation. And scratch tickets.
There’s no way she’s going to ever gain the knowledge to choose a basket of ETFs on her own. Traditionally, somebody like her would go down to the bank and an hour later emerge the owner of some overpriced mutual funds. If she uses a robo-advisor, she’s accomplishing the same thing while paying less in fees. It’s a decent deal.
But just because the fees are less doesn’t mean they won’t add up in the future.
The tale of two funds
Greg from Control Your Cash (RIP) used to call this the low-tar cigarette argument.
The average mutual fund in Canada has a management expense ratio (MER) of about 2%. Most of these funds are BAD NEWS, except there are a few that consistently outperform the market enough to justify their fees.
Then there are cheaper mutual funds. Tangerine has a total of five mutual funds that each charge 1.07% annually in management fees. This is a hell of a lot better than 2% or 2.5%. But it’s still damn expensive.
Say each of these Tangerine funds trail the market by 1% over the long-term. The market would make you 8% a year, while you’re taking home 7% a year with a Tangerine fund. It’s the same argument that’s been made in favor of index funds for years. The numbers are just smaller.
The sad part is I know personal finance bloggers who own Tangerine Funds. These people bill themselves as money experts, too.
Now let’s compare Tangerine funds to the average robo-advisor offering. If you’ve got $100,000 invested with Bank of Montreal’s robo-advisory service, you’re paying around 1% a year for fees. That drops to 0.9% with a quarter mil invested and 0.8% with a million bucks contributed.
Again, that’s a hell of a lot cheaper than a mutual fund. But it’s also way more expensive than just owning the damn index on your own.
The power of small numbers over time
Let’s crack out the ol’ compound interest machine and run a couple of scenarios.
The first investor uses a robo-advisor and pays, on average, 0.9% of their assets each year for the privilege of being able to phone somebody if they feel a little jittery. The market itself returns 8% a year, which means our investor makes 7.1% after fees but before taxes. He starts out with $10,000 (drug money, obvs) and adds another $10,000 each year from age 25 to 65.
Here’s how much money he ends up with.
Not bad, skippy. Not bad. Can I have a loan? I promise I won’t squander it on peanut butter cups.
Now let’s run the same scenario, but with an investor who finds the cheapest way to match the market. A portfolio filled with the cheapest Vanguard ETFs would average about 0.1% per year in fees. So we’ll assume our imaginary investor gets a 7.9% return.
The difference is staggering.
That “small” fee the average robo-advisor takes? It can add up to $600,000 over a lifetime. Or to put it another way, the person who minimized fees ended up with 25%(!!!!!) more money than the person who chose the so-called low-cost option.
Fees matter. Even small fees.
The crux of the argument is pretty simple. Switching from expensive mutual funds to cheaper alternatives is like cutting your three slurpees per day habit down to two. Sure, it helps, but it’s not the best solution.
Look. You read Financial Uproar. You’re smart enough to start investing on your own. There’s no reason for you to keep using a robo-advisor. I’m convinced that damn near anybody can figure this stuff out and then only consulting a professional when absolutely needed. All it takes is a little patience and reading a few books.
You owe it to yourself. Even if you’re not saving $10k a year, fees can still add up to a lot over time. Avoid them with extreme prejudice.