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ETFs of Note
Vanguard Canadian Aggregate Bond ETF (TSX: VAB) – Bonds did well over the three months ending April 30, as Canadian yields drifted lower across the board. At the short end of the curve, the yield on the Canadian five-year benchmark bond fell from 1.11% to 1.00%, while the ten-year dropped from 1.75% to 1.54%. At the long end of the curve, yields fell from 2.41% to end the period at 2.16%. Because bond prices move in the opposite direction of yields, bonds rallied higher, with this ETF, which represents a broad spectrum of Canadian bonds, gaining a very respectable 2.9%.
In the past few weeks, Canadian yields have continued to drift lower, despite many market participants expecting the U.S. Federal Reserve to bump rates higher at their upcoming June meeting. There is some evidence mounting that shows the Canadian economy is picking up some steam, I still don’t think we’ll see Canadian rates moving sharply higher in the near term. In this environment, I remain cautious, but still believe the benefits of including bonds in your portfolio outweigh the risks right now.
This remains an excellent way to access the broader Canadian bond market, particularly given the 0.13% MER. However, iShares recently announced they were cutting the management fee on the iShares Canadian Universe Bond Index ETF (TSX: XBB) from 0.25% to 0.09%, which will certainly give reason to re-examine. Stay tuned…
BMO Monthly Income ETF (TSX: ZMI) – This income focused balanced ETF continues to tick along, providing decent returns for investors, all while generating a nice cash flow to investors, which is currently yielding around 4% annualized. To deliver this, it has a neutral, or target asset mix that is roughly equally weighted between bonds and equities. At the end of April, it was modestly overweight equities, which made up about 53% of the portfolio.
A knock on this in the past had been that with the income focus, the valuation levels had reached a point that were cause for some modest concern. Since our last update, valuations have retreated slightly, and are now more in line with the benchmark. A contributing factor to this would have been the reduction to low volatility equities, which were nearly 6% of the portfolio at the end of January, and have since been reduced to around 2.5%.
Looking ahead, for those looking for a reasonably priced, income focused, “one ticket” balanced ETF, this fits the bill reasonably well. It offers decent returns, modest volatility and a cost that is reasonable, with an MER of 0.61%.
PowerShares S&P/TSX Composite Low Volatility ETF (TSX: TLV) – It was a good period for low volatility funds and ETFs, and particularly so for this PowerShares offering. With a gain of nearly 6%, it handily outpaced the broader Canadian market. A big reason for this outperformance was its underweight in energy, materials, and financials, three sectors that struggled during the past three months. Combined, these three sectors make up nearly two thirds of the index, but represent less than 30% of this ETF. Instead, it is significantly overweight to real estate, communications, and utilities, sectors which gained 5.4%, 9.3%, and 4.7% respectively.
One of the concerns I have had of late with many low volatility products has been their high levels of valuation. Many had been trading well above even the elevated levels of the broader markets. Looking at this ETF, according to Morningstar, it is trading about 8% below the S&P/TSX Composite Index on both a price to earnings basis, and price to cash flow basis. Further, the dividend yield is far superior that offered by the market, making this a somewhat attractive offering.
From a volatility perspective, this has certainly lived up to its promise, with a three, and a five-year standard deviation that is significantly lower than the index and the peer group. Performance has also been excellent, gaining a nearly annualized 12% for the past five years, compared to the S&P/TSX Composite which has generated around 9.2% annualized. While I am doubtful the outperformance can be sustained going forward, I do believe that it should be able to deliver market like returns, and I remain confident this can be done with a lower level of volatility. This, combined with a more than reasonable MER of 0.34% make this an ETF to consider for those looking for Canadian equity exposure.
First Asset Morningstar Canadian Momentum ETF (TSX: WXM) – Momentum names had a heck of a run over the three months ending April 30th, with this First Asset offering gaining 4.2% over the period, making it the second best Canadian equity performer on our list. It was largely its overweight in the consumer and technology sectors that helped drive returns higher. Telecom and utilities were also strong contributors during the period, although these are not sectors you would typically expect to see in a momentum focused fund, but Rogers, Quebecor, and BCE were all contributors.
Valuation levels look at bit rich when compared to the broader market, however, when we consider the significantly higher levels of earnings growth, things look a little more reasonable. This momentum strategy can invest in companies of any size, but tends to favour mid-caps. This will also help to explain why the volatility has historically been a little higher than the broader market.
Over the long-term, I expect this ETF can deliver a rate of return that is in line with, or higher than the broader markets. However, I also expect it to remain a bit more volatile, and that there will be periods where the performance is out of step with the major indices. I don’t view this as a core holding, but instead, I see it as a potential return enhancer when included in an otherwise well diversified portfolio. A drawback is that it’s a bit pricey, with an MER of 0.68%, however it is something that is not easily replicated by the average investor.
iShares Core S&P 500 Index ETF (TSX: XSP) – U.S. equities have had a heck of a run since the election, and continued that in the three months ending April 30, with a gain of 5% in U.S. dollar terms. Valuations continue to sit at levels well above other regions, trading at a price to forward earnings ratio of more than 19 times. In comparison, the S&P/TSX Composite Index is trading around 16.5 times forward earnings, and the MSCI EAFE Index is around 15.7 times. These levels are not sustainable, and the euphoria that followed Trump’s victory is now starting to fade, as controversy continues to follow Mr. Trump, and there have been a few campaign promises that have failed to gain enough support to pass. This is causing some market participants to pause. While I don’t expect there to be a significant correction, I would expect the U.S. market to take a breather at some point. Unfortunately, when that will happen cannot be predicted. Now may be a good time to think about taking some profits in your U.S. equity holdings, and looking at other areas, including Canada and Europe.
iShares MSCI EAFE Minimum Volatility Index ETF (TSX: XMI) – Low volatility ETFs had a great run, and this international offering is no exception, gaining nearly 12%. For the past three years, it has gained nearly 13%, outpacing the broader MSCI EAFE Index, which gained 9.7% in Canadian dollar terms. While the absolute results have been decent, this has not had the same type of success that the PowerShares S&P/TSX Composite Low Volatility ETF (TSX: TLV) discussed above, has had. Volatility for XMI has been lower than the MSCI EAFE Index, it has not been significantly lower. Further, looking at the valuation levels, it trades at levels below the U.S. markets, but are still higher than its benchmark. This causes me some concern, because with the higher valuation levels, I do not have the confidence that this can keep pace with the broader index in the near to medium term. If you have held this for a while, you may want to consider taking some profits. If you have an average or higher risk tolerance, you may also want to consider moving to the more broad-based index, such as ZEA or XEF. Both offer comparable exposure at a more attractive valuation level.
Vanguard FTSE Emerging Markets All Cap ETF (TSX: VEE) – After a tough 2016, the emerging markets had a nice bounce back as China, Korea, India, and Mexico all had strong showings, as economic numbers look to be on the upswing. Profitability is on the upswing, and valuations are very attractive, when compared to their developed market peers. However, the region is not without its trouble spots, as Brazil continues to struggle, political turmoil in Turkey, and rising debt levels in China are beginning to weigh. There are also some concerns over the impact of a potential border adjustment tax that may be levied by the U.S., which could hurt many developing nations, including Mexico, Columbia, China, and Singapore.
In this environment, I am optimistic on the outlook for the emerging markets, but cautiously so. Despite the valuation gap, and the earnings growth outlook for many developing nations, I am not confident enough to suggest an overweight position. Instead, I remain neutral in my allocation to the region. This is not an area of the market that is suitable for those with below average appetites for risk, and is only something you should consider if you are comfortable with the potential volatility.
I am also somewhat reluctant to use a pure passive strategy in the asset class, and instead favour a more quality focused, actively managed fund. However, for those looking for low cost exposure to emerging market equities, this remains one of the most attractive ways to do so. As mentioned above, this is not a core holding, but rather used as a potential return enhancer for an otherwise well diversified portfolio.
iShares S&P/TSX Capped Financials Index ETF (TSX: XFN) – Financials have long been the cornerstone of the Canadian equity markets, with the big five banks making up more than 20% of the total market capitalization of the S&P/TSX Composite Index. The financial services sector has been a stellar performer over the long term, outpacing the broader market by a decent margin. For the five years ending May 31, financials have gained nearly 14%, while the S&P/TSX has returned 9% give or take, while over the past three years, financials have risen by more than 8%, while the broader market gained 4.7%. Even with the higher volatility shown by the financials, they have outpaced on a risk adjusted basis.
Shorter-term however, things have not been quite as rosy for the financials, particularly the banks. In April, troubles at alternative mortgage lender Home Capital Group came to light, which saw the stock plummet from nearly $30 to just over $5. Investors sold off heavily after the Ontario Securities Commission announced it had filed disclosure allegations against the firm and key management. While it appears this came out of nowhere, it actually had roots going back to 2014, when management noted irregularities on a number of mortgage applications. They then began an investigation and found that several mortgage brokers were falsifying applications.
The fact that this fraud occurred and was discovered by management is not the issue. The fact that management failed to disclose this to shareholders and regulators is. As investors caught wind of this, there was a classic “run on the bank” as those with GICs and high interest savings accounts rushed to get their money out. As deposits dried up, the viability of the firm came into question. Many worried that this was just the tip of the iceberg and there were other Canadian lending institutions, including banks, that could be in a similar scenario. In this environment, the other Canadian banks also faced selling pressure, with financials losing ground in April and May.
Whether this is the end of the selloff remains to be seen. Canadians continue to carry very high levels of debt, which could result in problems should we see higher interest rates, or a slowdown in the economy. Since the initial selloff, financials have drifted lower. Valuations are now below the broader market, but there are some questions around the near-term earnings outlook as investors and consumers digest the record debt levels. We are also seeing tangible signs of a slowdown in the Canadian housing market, after government actions in Vancouver and Ontario appear to have put a chill on those markets.
Looking ahead, I don’t foresee a near term catalyst that will drive banks meaningfully higher, and in fact, I see significant headwinds. In this environment, if you have realized big gains from your XFN holdings, you may want to consider taking some money off the table, and trim your position modestly. If you have a longer-term outlook, and a higher appetite for risk, and are looking to add some financial services exposure to your portfolio, it may be a decent time to start dipping your toes in the sector, and this remains one of the best ways to play the broader financial industry.