EXCHANGE TRADED FUNDS
ETFs may be down, but they’re not out
As broad-based funds gyrate with the markets, look to specialty products to fill RRSP needs
BY GAVIN ADAMSON
Exchange traded funds offer performance that tracks today’s rough-and-tumble world of major indexes. If investors can stomach the volatility, advisers still recommend these low-cost funds as an efficient way to invest in RRSPs for the long term.
“It’s not a comfortable time to invest because it’s been so turbulent,” says Warren Baldwin, a financial adviser for T.E. Financial Consultants Ltd. in Toronto who occasionally recommends ETFs for clients. “But markets have very short memories, and in a couple of quarters things may look a lot different.”
If you can handle the ups and downs, ETFs – securities linked to the performance of a market index or a basket of assets – might be for you.
“They are products that are very empowering for the self-directed investor in Canada,” says Duncan Hannay, president of E*Trade Canada, one of several discount brokerages that has seen increased ETF sales.
The main benefit of ETFs is that investors “can buy them at much lower cost, with the lower expense ratios, and without any of the back-end charges or some of the limitations of traditional mutual funds,” Mr. Hannay says.
For example, the iShares S&P 500, an ETF that invests in the major U.S. equity index, charges a management expense ratio (MER) of 0.09 per cent. The average MER for actively managed U.S. equity mutual funds is at least 25 times that, and the difference can eat into your retirement savings growth.
More than 50 ETFs trade on the Toronto Stock Exchange, with assets totalling about $17-billion. Barclays Global Investors Canada Ltd. dominates this scene with 24 ETF products dubbed iShares. Claymore Investments Inc. and BetaPro Management Inc. offer specialty ETFs. All three firms are based in Toronto.
Many more ETFs can be found on U.S. exchanges.
Portfolio basics
Theoretically, with such a large batch to choose from, an RRSP investor could build an entire portfolio out of ETFs. Investors could choose to mix and match these funds with actively managed ones to help smooth the bumpy ride inherent in equities and in ETFs. Shoring up a broadly diversified portfolio that suits your goals is always prudent, says Mr. Baldwin, and ETFs can play a role.
Long-term investors – say, those with more than 20 years until retirement – can conservatively balance their retirement portfolios with 40 per cent fixed income and 60 per cent equities, Mr. Baldwin says. The equity portion should be evenly distributed among U.S., Canadian and international stock markets, he says, and both Barclays and Claymore offer such ETFs.
The older you are, the more you should tip the balance to bonds, Mr. Baldwin says. The Claymore 1-5 Yr Laddered Government Bond ETF automatically invests in a rolling portfolio of five guaranteed investment certificates and bonds. This offers the diversification of a bond mutual fund but without the cost of management.
Specialty funds
Investors interested in a specific investment theme, geographical area or business sector can invest in a specialty fund, though most advisers recommend against tipping the balance in an RRSP portfolio more than 5 to 10 per cent in such a way.
If you have a long-term interest in environmentally sensitive products, for example, Larry Berman, the portfolio manager for Toronto-based ETF Capital Management, suggests the PowerShares WilderHill Clean Energy ETF.
It invests in manufacturers and suppliers of clean energy products such as solar panels and windmills. “It’s a longer-term theme you may want to be in,” says Mr. Berman, who invests in it occasionally.
Those who want to invest internationally can buy ETFs focused on such areas as Japan or Europe. But currency issues should be taken into account, Mr. Berman says.
For example, the European economy is showing signs of slowing, and potential weakness of the euro is a liability, he says. He notes that the European Central Bank is often slow to reduce interest rates to encourage economic growth, and ultimately that will be reflected in the currency. “That will cost, over the coming months, 5 to 10 per cent of performance in my view,” he says.
Mr. Berman goes so far as to suggest shorting European and international markets with the ProShares UltraShort MSCI EAFE ETF. It hedges against an index invested in stocks trading in Europe and Asia.
Today’s market
Investors who are already in the market and nervous about its recent downward slide should consider investing a portion of this year’s RRSP contribution in ETFs that short equity bear markets, says Danielle Park, a portfolio manager at Venable Park Investment Counsel Inc. in Barrie, Ont.
“I have never recommended that investors short stocks, but this is a relatively safe way of achieving the same objective, and minimizing your risk of losses,” she says.
The Horizons BetaPro S&P/TSX 60 Bear Plus ETFÖ gives investors a heightened hedge to the Canadian index. If the index falls 2 per cent in a day, the ETF gains 4 per cent. Conversely, if the index rises 2 per cent, the ETF loses 4 per cent.
The hedge should make up no more than 5 per cent to 10 per cent of a portfolio, Ms. Park cautions. She says hedging is not a long-term strategy but a tactical one to be used occasionally. to give your portfolio some defence.
For now, Ms. Park is recommending that investors take a defensive position in cash or GICs. For those who wish to hold cash for an extended period, an alternative is the Claymore Premium Money Market ETF.
© Copyright 2008 CTVglobemedia Publishing Inc. All Rights Reserved.
