The second instalment of The Globe and Mail ETF Buyer’s Guide covers what could be the most confusing category of them all for investors.
All the usual selection criteria apply when researching TSX-listed exchange-traded funds covering the U.S. stock market – including fees, the index being used and the diversification being offered. The extra step with U.S. equity funds concerns currency hedging. Many ETFs have it, a growing number don’t and a few others give you a choice of hedged or unhedged exposure to U.S. stocks.
A quick primer on hedging: It eliminates distortions to index returns caused by fluctuations in the Canadian dollar against the U.S. buck, while also adding a bit to an ETF’s fees in some cases, and contributing to tracking error. That’s where an ETF’s returns wander off the ideal path of index returns minus fees. Hedging means your U.S. returns won’t be undermined when our dollar rises, nor will they be enhanced when the dollar falls. If you forgo the hedge, you lose out when our dollar rises and benefit when it falls. The purpose of this guide isn’t to recommend hedging or not – that’s your call. Rather, it’s to round up your ETF options for investing in the broad U.S. market and help you make an informed choice.
ETFs are a low-fee version of mutual funds that trade like a stock. Traditionally, ETFs tracked major stock and bond indexes; today, many funds follow more obscure indexes or have a manager who picks stocks. To invest in ETFs, you need a brokerage account. For help on that, consult my latest ranking of online brokers (read it here).
The Globe and Mail ETF Buyer’s Guide will cover a variety of asset class, including Canadian, U.S. and international equity, dividend funds and bond funds. The first instalment appeared Nov. 9 and you can read it here). Look for further chapters in this space in the weeks and months to come.
Here is an explanation of the terms you’ll find in the ETF Buyer’s Guide:
Assets: Shown to give you a sense of how interested other investors are in a fund; the smallest funds may be candidates for delisting.
Management expense ratio (MER): The main cost of owning an ETF on an ongoing basis; as with virtually all funds, published returns are shown on an after-fee basis.
Trading expense ratio (TER): The cost of trading commission racked up by the managers of an ETF as they shuffle the portfolio to keep it in line with a target index; add the TER to the MER for a fuller picture of a fund’s cost. Note: Most U.S.-market ETFs do so little trading that their TERs round down to zero. Full year 2012 numbers are presented here.
Dividend yield: Mainstream indexes can be a source of dividend income
Average daily trading volume: Trading of less than 10,000 shares per day on average tells you an ETF isn’t generating much interest from investors.
Distribution frequency: How often are dividends paid out?
Top three sector weightings: U.S. market ETF are typically dominated by sectors that are under-represented in the Canadian market, notably technology and health care.
Top three stocks: Another view on what’s inside an ETF.
Launch date: Shows you how long an ETF has been around.
A final note about hedging: ETF that are hedged typically have the term “CAD hedged” in their name, with CAD being an investment industry short-form for the Canadian dollar.