Live ETF Portfolio Tracking

It took more than a few hours of experimentation and lots of poking around the Internet but I finally found a way to show my portfolio of ETFs on this blog for one and all to see. You can find it on the bottom of this blog page as a Google spreadsheet.

The portfolio spreadsheet includes:

• all the Canadian and US holdings together, with the US holdings converted into Canadian dollars;
• live pricing of all the holdings, courtesy of Google Finance, at least I hope that it updates live as posted; it did while I was editing it on the web; we'll see tomorrow;
  
• that includes live conversion of US dollars into Canadian dollars (during the North American trading day at least); this part required a bit of finagling using the FXC Canadian vs US dollar currency ETF as an approximation but there seems to be NO direct way of getting live currency rates into a portfolio calculation on the web at the moment;
  
• gains or losses by holding and for the overall portfolio, which can be used to see potential capital gains and perhaps later in the year facilitate some tax loss selling;
• gains or losses and movements away from the target percentages by asset class, which will enable quick and simple portfolio rebalancing come next May;
• a separate tab/sheet for the asset allocation model I used, including some notes on how and why I picked the ETFs I did, as well as credible alternatives; note that the allocation percentages get pulled from the this sheet into the main portfolio sheet so if I decide next year to change my percentages among classes, it will be quicker to see what buys/sells are required;
  
• another separate tab for tracking the Adjusted Cost Base for Canadian tax purposes - the one on the spreadsheet below is actually an edited one of my own real one, since I am too shy to reveal the details of my financial affairs, but I hope it is of use to others who may be looking for a simple model; here again I've pulled some of the ACB data per share into the main spreadsheet in the "Cost May 23" area; if one is buying holdings at different times, the only way to keep track of the ACB of US holdings for Canadian tax purposes is to do some sort of journal with US exchange rates applied at the time of purchase (not those in effect at the time of eventual sale, unless you either want to make a gift to Revenue Canada, if the C$ continues its upward path, or get in trouble with Revenue Canada, if the C$ starts heading back down;

Comments and suggestions on improvements most welcome. If you want, I believe you can take a copy from here or maybe here (.xls format). One thing I found in copying the spreadsheet back to my own PC (since it's a lot easier to edit than doing so online) is that some formulas disappeared in the transfer, notably the essential =GoogleFinance function that fetches the live quotes (is Google trying to ensure that this function is only used online?).

Retirement and Rewards thereof

Just a quick post today since I'm off shortly to enjoy one of those benefits of retirement. It's a lovely day out here in Scotland and those are not to be missed (at some points during the past winter, one had the impression that it was time to start building an ark, though my scottish friends assure me it wasn't normal weather) so I'm going golfing this afternoon, a last minute decision that comes with the freedom of time allocation to do things when one wants.

I want to welcome a former work colleague to the fold of retirement. Well done and congratulations, B! Enjoy. Life is not worry-free, though it pretty well will be on the financial side with the inflation-indexed pension for life. We can all appreciate things more having experienced and observed the downsides of life, as we have with another work colleague who had an accident recently. Get well soon, H!

Carpe diem!!

BMO Investorline Modifies Foreign Currency Notice

Back on May 27th I posted this complaint about BMO Investorline's lack of disclosure with regard to the foreign exchange rates used when one trades in foreign securities, like those on US markets, on top of the fact that BMOIL does not allow foreign currency to be held within registered accounts, so making unjustified profits for BMOIL in the obligatory two-way currency exchange. Curiously, upon login to my account this morning, I discover that a new notice has suddenly appeared on BMOIL's webpage (see graphic).

Probably this is a coincidence since it is highly unusual for a big organization to make any change in response to an individual's complaint (large organizations by their nature only respond to an appropriately large stimulus, like losing a major lawsuit, getting into major financial problems etc). This notice doesn't provide any better disclosure, it merely says BMOIL can set whatever foreign exchange rates it likes on transactions. That neatly covers their liability, of course, which is BMOIL's primary objective. But it doesn't help investors trade accurately by having exact rates at the time of transactions. Nor does it seem fair for BMOIL to set whatever rates it likes, particularly since BMOIL only sets the rates at the end of the day, long after the trade has been committed. That BMOIL is trading the foreign currency for its own profit makes this unfairness even worse.

Another curiousity is that the link to the full agreement takes one to a pdf document dated March 2007. If there is something "new" in the agreement, wouldn't a more accurate date be June 2007, or is it allowed to retroactively change agreements? Just asking....

The Best US Large-Cap Index ETFs Compared

Back in May in my post on the complete overhaul of my portfolio, I showed a chart of my selected ETFs along with some credible contenders in several asset class categories. In one of these, US large-cap companies, my choice was Vanguard's offering, the Vanguard Large-Cap Index Fund (ticker VV), over some very good other choices, the iShares S&P 500 Index Fund (ticker IVV) and the grand-daddy of ETFs, the SPDR aka Spiders (SPY). Along with those, I've included the iShares Canada S&P 500 currency hedged version (XSP) and the TD e-Series S&P 500 currency hedged fund (fund symbol TDB904) for the benefit of Canadian investors like me who don't want to face the negative consequences of a Canadian dollar continuing to rise vs the US$.

The chart illustrates the factors that I believe justifies the conclusion that Vanguard is the best, though not by a great deal. I've coloured the cells light blue where the particular factor favours that ETF. The visual impression is a bit misleading since a number of cells at the bottom all have to do with tax efficiency.

Vanguard's VV is better on:

• MER, or Management Expense Ratio, which is the overhead paid to Vanguard to manage the fund - the lower the number, the better it is for the investor
• on the premium/discount, in this case the discount, which is the average amount the market price of the ETF deviates from the Net Asset Value (NAV), the value of the under-lying stock holdings; the smaller this number the better, the investor neither gains nor loses as the fund is fairly priced; in this case VV is tied with SPY for the best
• 3-year performance, which is higher in VV's case; now some will note that VV uses a different index than all the others, which use the S&P 500 and thus the result should not therefore be comparable. I'm going to stick my neck out a bit by saying that the others suffer from using the S&P 500, a flawed index (as noted by Peter Bernstein in his book, which I reviewed a few days ago). Check out the text below on the S&P 500's flaws and see if you agree with me. The fact that everyone uses it, as they do the far worse Dow, doesn't make it good!
• all the various tax efficiency measures; especially note that the ratios at the bottom of the table, higher in VV's case, mean that the investor loses less to the government through taxes on VV than the other funds. Canadians should note that the source of this is US websites like Vanguard and the absolute numbers reflect US taxpayers but I believe the relative advantage of VV is still there. The size of the 2006 distribution by VV, which would be a highest-rate income item for a Canadian, compared the that of IVV, confirms this conclusion.
  

There are a bunch of blank cells in the table, where I could not find the numbers despite hours of searching. Canadians will note more blanks for XSP and TDB904, where the available data on comparative websites like Morningstar, GlobeFund and those of the providers iShares Canada and TD Asset Management don't seem to be very forthcoming with data. I had to email iShares Canada to learn why their 3-year performance figure on their website differed so markedly from the S&P's results - turns out they only started hedging XSP in November 2005. Therefore, all note, the numbers may not be 100% accurate!

One disappointment for me in all this is how much one loses in buying XSP or TDB904 for currency protection. There's a big performance loss. It's curious that XSP managed in 2006 to distribute some of its distribution as capital gains instead of income, better because of the lower tax paid on capital gains over income. The tracking error of TDB904 at 6+% is abysmal. I had to calculate that one myself so it may be wrong but the high cash holding of 4% of assets, which came from Morningstar Canada, is consistent with such poor tracking.

The suggested weaknesses of the S&P 500 as a market index include:

• it is really only a large cap index with about 75% of the total market value of US shares
• it weights the companies within the index based on the value of the public float in the judgement of the Standard and Poors selection committee, so this biases the index away from a true market cap weighting that follows from financial theory
• some non-US companies are still in the index, having been grand-fathered upon moving away from the US
• some US companies that are illiquid are excluded like Warren Buffett's Berkshire Hathaway, a gigantic omission as it is a huge company
• delays in adding new companies in new sectors distort the true market weighting – it took a while before Google entered the S&P 500

see http://en.wikipedia.org/wiki/S%26P_500 and a letter by Darren Bramen on this page http://www.aicpa.org/pubs/jofa/apr2000/letters.htm

Book Review: Capital Ideas by Peter Bernstein

This is a book nominally for finance aficionados, those interested in the theorists who explained stock and bond markets and laid the basis for index funds, portfolio construction and the explosion in derivatives. Capital Ideas is about the history of the thinkers and some implementers of modern capital markets.

Peter Bernstein, not to be confused with the other popular financial author, William Bernstein (he of Four Pillars fame), writes in a non-technical way about the theories. This is quite an accomplishment, given that modern finance is highly mathematical. In fact, there is only one brief formula in the book, which Bernstein throws in just to show us how complex a formula can be. The Black-Scholes formula for pricing options is the only one in the book (228). There might have been a few more, if only to make a deeper impression on the reader about the difficulty of the intellectual work involved. When doing my MBA in 1982, we went through the mathematical derivation of the Capital Asset Pricing Model, another core financial theory, and I remember feeling quite smart merely at being able to understand and follow the logic. UBC did that because it was a fairly quantitative business school. Most MBA schools at the time did not even go that far, merely presenting the final formula with words to describe its meaning. The Black-Scholes was another order of magnitude more difficult than the CAPM with its reliance on Ito's lemma for the solution and we did not attempt the math. However, to really understand any formula properly in order to apply it intelligently, I maintain that you must be able to do the math, otherwise the intricacies and subtleties are lost. There are likely even today, 30 years later, no more than a few thousand people in the world who truly grasp how options pricing works. Though I consider myself to be of reasonable intelligence, particularly in an academic sense, I feel in awe of the finance theorists that Bernstein pays homage to. It is hard to comprehend the abilities of these individuals. On reading that some of these guys came out of physics, I was reminded of my late wife, who had a doctorate in nuclear physics. She described how she used to pass undergrad physics exams – go to class, listen very carefully to understand what the teacher was saying, remember a few basic principles and formulae, then go to the exam and re-derive whatever additional formula a particular problem might require! It's like any field of endeavour – think what Tiger Woods does with a golf ball - the best are simply amazing to anyone with ordinary abilities. Bernstein might have imparted more of the sense of awe that we should rightly feel.

One of the lasting impressions of the book is amazement at Bernstein himself and his ability to understand and explain the many theories, some of them quite subtle indeed. Not everyone seems to get the message of modern financial theory however, as Bernstein describes in the last chapter. There are many portfolios being managed in the institutional world, which is supposed to be professional, in un-diversified, active trading. Some of the managers probably don't understand the theory properly and so mis-apply it.

There are a number of delightful snippets of information and quotes to give a reflective reader something more to think about:

• The long run returns of the US market of about 8% annually on a real, after-inflation basis, are unique to the United Sates in the 20^th century. No other country has done as consistently well, due to disruptions such as wars, famines, revolutions and the like. (A recent paper by Bernstein suggests that using the number as an assumption about the future rate of return is probably much too high.)

• Or, for us index investors, the S&P 500, is not a very good index. It doesn't represent the market very well, which is what finance theory says a good index should. Bernstein calls the S&P 500 a “a capriciously structured portfolio” (page 248).

• Change in financial markets, and in the practices of those in the business, tend to change after major disruptions like the 1973-74 and the October 1987 severe drops. In the interim, people are smug, fat, happy and resistant to change.

• Financial theorists have been almost exclusively English and American scholars, though that seems to be changing now. And they have been 100% men. Not a woman figures among Bernstein's pantheon. So many theorists were converted engineers, physicists and mathematicians (I think that's where the “improbable origins” subtitle of the book comes from; these guys were just looking for some good problems to work on). It's the ultimate nerd activity.

• The value and significance of research is not immediately apparent, recognized or adopted: Markowitz' paper on portfolio selection languished nearly 10 years after its publication before people took much notice. Or, Black and Scholes submitted their paper on options pricing first to a Chicago University journal and then to one at Harvard, who both promptly rejected it. (220)

• Things can change permanently: in the years after the 1929 crash stocks were considered so risky that the dividend yield on stocks was nearly three times the interest on savings accounts. In the the 1950s stock prices overtook bond prices for the first time in the history of over 100 years of the US market. That relationship has never returned. “Growth had replaced solvency in market valuation.” (160)

There are amusing and useful sayings for the investor:

• “Diversification depends more on the way individual securities perform relative to one another than it does on how many assets the investor owns. In Markowitz's terminology, “It is necessary to avoid investing in securities with high covariances among themselves.”” (50)

• “Diversification takes all the fun out of investing.” (53)

• “The riskiness of a portfolio depends on the covariance of its holdings, not on the average riskiness of the separate investments. A combination of very risky holdings may still comprise a low-risk portfolio so long as they do not move in lockstep with one another – that is so long as they have low covariance. (54)

• The market is so hard to outguess because so many people are out there doing the guessing. (134)

• “The only thing the investor should worry about is how much any asset contributes to the risk of the portfolio as a whole.” (188)

The book has an extensive bibliography with details of all the major papers and books, providing a handy reading list for the essential sources of modern finance up to the date of the book, which was published in 1992.

Buy the book at
chapters.indigo.ca

Tech Stock Accounting Foresight in Hindsight

Those interested in tech stock investing, or indeed in buying shares of any individual company, should run through this column on devious tech accounting methods, written at the beginning of the tech bubble in 1999 by tech commentator/blogger Robert X. Cringely. It foresaw and forecast the coming accounting fiascoes with tech and Internet companies such as the one where I worked for a while, Canada's darling Nortel (mea culpa, I drank John Roth's cool-aid too). It reminds me of something I read years ago to the effect that the real financial analysts read annual reports backwards - starting with the footnotes at the end, where the financial dirt is hidden.

Cringely is always a good read for anyone who likes technology. That he has been around for ten years on the Internet as a columnist is an impressive achievement,, which I can better admire having blogged for several months now. The quality and value of his writing is consistently high. I take him as a role model to emulate in that way - to write original, well-researched, topical and forward-looking material.

Anyone have a financial columnist/blogger to suggest as their hero?

Why Management Expense Ratio is So Important

One tenth of one percent (0.1%) seems like a trivial number not worth bothering about when it comes to the expenses charged by fund companies to manage our money in mutual funds or Exchange Traded Funds (ETFs), doesn't it? The expense ratio (ER or MER) is the amount levied by the management company as a percentage of net assets in the fund. It is not in any way dependent on the investing success or performance of the managers (see the Wikipedia post on mutual funds for details).

Another way to look at the ER is that it is a reduction in the net return available to fundholders. Managers must make up their percentage fee and better in order to make money for you and me. For example, if the fund is $100, the ER is 1% or $1 per year, in order to gain 6% net, the fund must go up by 7%/$7. Alternatively, the same net gain can be achieved with a lower investment gain and a lower fee. Or, to put it yet another way, with same investment gain, as I am illustrating in this post, and a lower fee, the net gain is higher. In the case especially of passive index funds whose aim is to replicate the gains (and the losses when they occur) of an index such as the S&P 500 or the TSX, there shouldn't be a lot to pick from between various ETFs or funds. Therefore, the lower the expense ratio, the more of the index gain is left for the investor. Since the MER is a known, predictable expense, the opportunity to lower it is pretty well a guaranteed, risk-free return. In short, the lower MER, the better, other things being equal (and they aren't always but interestingly those funds with lower MERs tend to be better in those other things too).

So how much does it matter? I've created a simple table in the accompanying graphic to show the numbers and the results are dramatic. The table shows percentages which are to be understood as the difference in rates of return - i.e. the effect of extra or less MER. Thus the table shows what an ETF/fund that charged 0.1%, 0.2%, 0.5%, 1.0% or 2.0% more would have produced. For example, the Vanguard FTSE All World ex US (VEU) has an MER of 0.25% while the iSharesMSCI EAFE (EFA) has an MER of 0.35%. They are not exactly the same index but the effect of difference of 0.1% in MER will amount to $201.91 after 20 years for every $10,000 invested, as shown in light blue cells of the graph. Multiply by the size of your portfolio to see the total amount.

$201.91 is a relatively small difference but the other columns show how significant the compounding effect can be for long periods and bigger MERs. The 2.0% column is of special interest to Canadians who pay the highest fund expense fees, which are high by something approaching 2% in my view. The moral of the story is to pay close attention to MER - the lower the better.