ETF recommended list review

For the fall, the best offense is a good defense

Despite market volatility taking a vacation throughout the months of July and August, we expect that it, like the rest of us will be back at full strength as we enter the fall. Many of the macro factors that have been responsible for the uncertainty in the past several months continue to weigh on the markets. Europe’s debt crisis is not any closer to having a workable solution in place. The U.S. economy is continuing to show some signs of recovery, with housing finally appearing to be on the upswing. While this is a very encouraging sign, it could all be derailed if the U.S. is allowed to fall off its “fiscal cliff.” The fiscal cliff is a mix of tax increases and spending cuts, that if allowed to be implemented will surely put the fragile recovery out of its misery. Also on the minds of investors, China and the emerging markets continue to post slower economic growth, which is affecting the demand for energy and commodities.

Given the current environment, combined with the history of September and October being nasty month for investors, we are taking a more conservative stance. In doing so, we are placing a bigger emphasis on fixed income. We believe that in the next couple of months, fixed income will provide investors with safe harbor during the heightened volatility. While there is no doubt that interest rates will have to move higher in the future, with the pace of economic growth being lackluster at best, there is virtually no chance that the Bank of Canada will have to step in and raise interest rates in the next three months.

We are not suggesting that investors sell their equity holdings. Instead, we are looking to take advantage of any market declines as an opportunity to add to our equity exposure.

Upgrades and New Additions

iShares 1-5 Year Laddered Corporate Bond (CBO) – This new addition to our Recommended List focuses on investment grade corporate bonds with maturities between one and five years. It has a duration of 3.89 years and a weighted average coupon rate of just under 4%. It is a nice compliment to the government focused CLF.

iShares S&P/TSX CDN Preferred Share (CPD) – Preferred shares can be a great way to add some equity exposure without taking on as much risk as is associated with traditional common shares. This ETF provides exposure to a diversified portfolio of preferred shares. The portfolio quality is high with more than half invested in preferreds that are rated P1 – the highest rating available. It pays investors a monthly distribution of $0.066 per unit, which translates into an annualized yield of 4.6% at current prices. We expect that this will hold up relatively well during periods of high volatility and still provide the monthly distribution.

BMO Equal Weight REITs Index ETF (ZRE) – We like the medium term fundamentals of the REIT market and we believe that this ETF is the best way to access the REIT market for Canadian investors. We like ZRE over the iShares S&P/TSX Capped REIT Index for two main reasons. First is that ZRE has a larger number of holdings providing better diversification over XRE. Second, it offers a higher yield than XRE. Costs are very comparable between the two ETFs.

Downgrades and Deletions

iShares Advantaged U.S High Yield Bond (CHB) – Despite downgrading this ETF to a HOLD, we still like it as a great way to add high yield to your portfolio for the long term. However, given our expectation of increased volatility in the fall, we are favouring investment grade and lower duration ETFs for the near term as we expect them to be outperform in the near term.

iShares S&P/TSX Completion Index (XMD) – Historically, when a market decline occurs, small and mid cap stocks tend to be hit the hardest. Because of this, we are downgrading this ETF to HOLD for the near term.

iShares S&P/TSX Canadian Dividend Aristocrats (CDZ) – While we don’t expect a drop in the markets like we witnessed in 2008, we do expect higher volatility. Because of that, we are very cautious of adding to any new equity positions at the moment. Therefore, we are downgrading this ETF to a hold for the near term.

iShares Global Monthly Advantaged Dividend (CYH) – We are expecting a return to high levels of volatility. Because of that, we are very reluctant to add t any new equity positions at the moment. Therefore, we are downgrading this ETF to a hold for the near term.

BMO Global Infrastructure (ZGI) – While we like this ETF as a long term play, it appears that it may have hit a near term high back in July. Given that, combined with our expectation of higher volatility, we are downgrading the fund to a HOLD for the near term.