Be Wary Before Buying Specialty ETFs

Be Wary Before Buying Specialty ETFs

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.

Company % Change in Share Count
West Fraser Timber -6.6%
Rogers Communications 0.0136%
Dollarama -17.2%
Canadian Tire -11.5%
Brookfield Asset Mgmt 3.79%
Methanex -6.56%
Canadian National Railway -8.26%
Royal Bank 3.04%
Cameco 0.08%
Great-West Life -1.3%
Average -4.45%

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.

Company % Change in Share Count
Encana 31.3%
Magna International -13.6%
Valeant Pharmaceuticals 4.44%
BlackBerry 2.24%
Saputo -0.18%
CP Railway -16.6%
Constellation Software 0%
Alimentation Couche-Tard 0.87%
Dollarama -17.2%
Average -0.87%

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.

Reminder: Don’t Invest With Investors Group

Reminder: Don’t Invest With Investors Group

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.

Investors group dividend 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.

Your Robo-Advisor is Going to Cost You. Big Time.

Your Robo-Advisor is Going to Cost You. Big Time.

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)

(regrets nothing)

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.

robo scenario 1

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.

robo scenario 2

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.

The 10 Best Dividend ETFs in the United States

The 10 Best Dividend ETFs in the United States

Last week we look a closer look at the 10 best dividend ETFs in Canada. It was filled with covered call ETFs, high-yield bonds, REITs, and one hot little fund which held a little bit of everything, the iShares Diversified Income Fund. That bad boy was sexier than that time I typed 58008 and then flipped my calculator upside down.

Yeah, that’s right. A grade three joke. Go ahead, stop reading. I’m practically daring you at this point.

One thing I noticed about this exercise is the universe of high-yield dividend ETFs up here in Canuckstan is a little lacking. Our ETF market just doesn’t have the weird variety that the U.S.’s does.

So I decided we’d expand the exercise. Here are the 10 best U.S. dividend ETFs.

The best U.S. dividend ETFs table

Like last time, we’re going to stick these bad boys into a table and sort them by yield.

ETF Yield
Etracs Monthly Pay 2x Leveraged Mortgage REIT (NYSE:SMHD) 21.4%
Etracs Monthly Pay 2x Leverage Closed-End Fund (NYSE:CEFL) 19.4%
Infracap MLP ETF (NYSE:AMZA) 18.4%
Etracs 2x Leverage Business Development Company Index (NYSE:BDCL) 15.9%
Etracs 2x Leverage Wells Fargo MLP (Ex-Energy) (NYSE:LMLP) 14.5%
Etracs 2x Leverage U.S. Small-Cap High Dividend ETN (NYSE:SMHD) 13.4%
Etracs 2x Leverage Diversified High Income ETN (NYSE:DVHL) 12.8%
Exchange Traded Concept Trust (NYSE:YYY) 10.1%
U.S. Equity High Volatility Put Write Index Fund (NYSE:HVPW) 9.7%
SPDR Dow Jones International Real Estate ETF (NYSE:RWX) 9.2%

A couple things to mention before we go any further:

  • ETF screeners are 46 different kinds of useless. I would pay at least $3 to use one that doesn’t suck. Thus, this list may not be complete
  • And I omitted a few funds that looked very similar to ones listed here

A lot of these are double-leveraged ETFs, which is good. I only have to explain the concept once and then apply it to all sorts of different asset classes.

These double-leveraged ETFs are all the same. They invest $1 and borrow an additional $1 to put in the fund. If the debt is at 2% and the underlying assets pay 8%, it creates 6% more income on the leveraged side of the equation.

Here’s a simple example. You have $100 that pays you $10 per year. You borrow an additional $100 at 3% and invest it at $10 per year. Which means you’d end up with:

  • $200 invested
  • $20 in income
  • $3 in expenses
  • $17 in profit

And that’s it. You’ve created a 17% return on your original $100 investment. Isn’t leverage fun?

Real estate investors do this all the time. This is how the concept of cash-on-cash return came to be. The problem with cash-on-cash return (or as stock market investors call it, returns on equity) is all you need to do to increase your return on equity is borrow more money. If we increase the amount borrowed to $200 in our original example, you get $24 in profit, or a 24% return on equity.

If you’re doing such a thing to buy a house, and it’s a property you intend on holding for a long time, it’s not so bad. The problem becomes when you use leverage to buy things that track the whims of the stock market. If such an investment would fall by 50%, you’d be more screwed than a teetotaler at a frat party.

The other risk with leveraged income ETFs

There are two reasons why a company would introduce a 2x leverage income ETF. The first is to make money on the ETF itself, obvs. Most of these products have fees flirting with 1%, which are exceptionally high for ETFs.

The other reason is to profit lending the ETF the money, although as far as I can tell this isn’t excessive. The UBS leveraged ETFs are being charged the three-month LIBOR rate, which is just a hair over 1% annually.

Now it’s time to talk about risk. If stock markets all go to hell and this thing loses a whole bunch of money, the creditor will always get paid first. So, in theory, if any of these leveraged ETFs fall 50%, the issuer could just wrap them up, pay off the creditor (themselves), and leave the investor with nothing.

You also have to worry about the credit of the issuing company. What happens if UBS runs into real financial trouble? It’s not exactly known as a top tier bank these days.

The other ETF

There’s really only one name on this list that isn’t levered to hell, and that’s the last one. Let’s take a closer look at the SPDR Global Real Estate ETF.

It’s got $3.6 billion invested in REITs (and other real estate companies) that aren’t in the United States. 25.5% of assets are in Japan, followed by 15.5% in Australia, 12.6% in the UK, 11.6% in France, and so on. There are a bunch of countries represented.

The ETF has 135 different holdings, and it has an MER of 0.59%. The SPDR website lists the yield at closer to 8.6%, but it still seems like a decent income option. The other thing this fund has going for it is it’s a bet against the U.S. Dollar. If the dollar falls versus other currencies, those currencies will be more valuable. This will increase income without doing anything, at least in local currency.

If you’re looking for a real estate ETF for your portfolio, I don’t hate this one. You’ll only have minimal exposure to Canada’s housing bubble.

How to Invest in Mexico

How to Invest in Mexico

This is the fifth installment of the “invest in blank” series. Today’s topic is how to invest in Mexico. I’ve previously looked at how to invest in Poland, Russia, Turkey, and Pakistan. I’ll probably look at a couple more countries before the series is over. Or not. I like to keep you guys on your toes. 

Ah, Mexico. Your beaches are fine, your ladies lovely, and your streets are filled with millions upon millions of drug dealers. Or so the internet has told me. What do y’all expect, research?

Also, this picture:

Don't run into this guy. Sean Penn I mean. His friend seems nice.

The guy on the right is El Chapo. Remember him? He’s much less dangerous than Sean Penn.

Mexico has been in the news lately for being Donald Trump’s bitch. The new President campaigned on the promise of building a wall to keep Mexican workers fleeing the country out of America, a project that looks like it’ll be paid for by a tariff on Mexican goods coming back to the United States. The country exported a little less than $250 billion worth of stuff to the United States (or about 80% of total exports), so a 20% tariff would be a big deal.

Mexico’s economy has slowly grown into one of the world’s largest, with a GDP of $1.1 trillion. Canada’s GDP is $1.6 trillion, but we manage to produce that much with about half the population. GDP per capita is a little less than $9,000. Economic growth has averaged between 1-2% for the last decade. Nothing exciting.

Oil’s decline has hurt Mexico, and so will anything that impacts the industrial sector. If the 20% tariff on Mexican goods comes into force, it could impact everything from making cars to growing tomatoes.

Mexico isn’t a particularly cheap country, either. Its main stock market index has a CAPE ratio of 21.5 and a trailing price-to-earnings ratio of 21.1. It trades at 2.4 times book value and 1.4 times sales. It is one of the most expensive stock markets in the world, and pretty much twice as expensive as Turkey, Russia or Poland.

If you’re going to invest in Mexico, I’d suggest picking individual stocks. The good news is this is far easier to do with Mexico versus almost every other country. Dozens of Mexican stocks trade on U.S. exchanges.

How to invest in Mexico — individual stocks

I’m going to borrow the first individual stock idea from Ian Bezek, the guy who’s probably responsible for 100% of Financial Uproar’s Mexico-based visitors. He’s a former hedge fund guy who lives there.

He likes Gruop Aeroportuario del Pacifico (NYSE:PAC), four words my spell check does not. It’s a holding company that owns a bunch of Mexican airports, including Guadalajara, Tijuana, Cabos, and Puerto Vallarta. Despite its largest airports posting fantastic growth, it trades at a little over nine times enterprise value-to-EBITDA. That compares to valuations of between 15 and 20 times EBITDA for comparable European airports. It’s cheap and pays a 5% dividend.

About a year ago I took a closer look at Grupo Mexico (OTC:GMBXF), which owns a big chunk of Southern Copper Corp (NYSE:SCCO), along with owning FM Rail Holding, which is Mexico’s largest railway. It has more than 10,000 km of track.

There were rumblings the company was going to spin out the rail division into its own company. Based on the valuation of other North American rails, there was some value there. But that plan looks to be shelved, so don’t expect any near-term pops from that. Could be a decent long-term play though.

The ETF route

As always, it’s much easier to use ETFs to invest in Mexico. But like I mentioned, it’s hardly a cheap country. I’d be more inclined to avoid it if I was a guy who only invested with ETFs. It’s a stock pickers market, in other words.

The big Mexico ETF is the iShares MSCI Mexico ETF (NYSE:EWW), which has a market cap of just under $2 billion. It trades about a million shares per day on average and is flirting with a 52-week low because of the whole Trump dealie. It has a yield of about 2.5%, which isn’t bad, and an expense ratio of 0.48%.

The largest holding is America Movil L, which provides wireless service to customers in about 20 countries. About 12% of the portfolio is invested in that one stock. Other large holdings include Fomento Economico Mexicano (FEMSA), which is a conglomerate that owns a bunch of different holdings including a Coca-Cola bottler, a chain of convenience stores, and a soccer team. It’s 8.3% of assets.

Other top holdings include Cemex (7.5%) of assets), GPO Finance Banorte (7.1% of assets), and Grupo Mexico (6.5%). I just cannot get enough of these goofy Mexican names. My favorite is definitely Grupo Bimbo, a company I surprisingly did not name in a drunken stupor.

Let’s end this

Personally, I wouldn’t invest in Mexico. Not right now, anyway. Their market is every bit as expensive as Canada or the United States. The country has a bunch of conglomerates that would probably create some value if they broke themselves into pieces, but I doubt that’s going to happen. You’ll do better putting your money somewhere else.