This past week BMO announced the startup of a bunch of new ETFs. The one that intrigues me the most is the BMO Low Volatility US Equity ETF (Symbol: ZLU). It is described as being constructed with the same method as the BMO Low Volatility Canadian Equity ETF (ZLB) that uses beta (stock price movement relative to the market average) to pick stocks that are less volatile i.e. low beta stocks.
As I blogged about just recently, passive rules-based alternative selection & weighting schemes (so-called smart beta) are coming to be accepted as being superior to traditional market-cap passive indices as an investment strategy. ZLU fills a gap in the smart beta space for US equities for an ETF using beta instead of simple price volatility e.g. funds like SPLV. Russell had some low beta US equity ETFs on the market for a while but closed them down due to lack of uptake. A mix of funds with different non-market cap weighting schemes in a portfolio is the way to go (e.g. this relatively simple smart beta portfolio), so ZLU is a useful additional component.
It is interesting to see how different market conditions in Canada vs the US are affecting low beta/volatility funds in comparison to the market-cap benchmarks. US equities have been on a tear recently as we read about all-time market highs. High beta ETFs like SPHB have been outstripping the market in the short term, such as the past 6 months, but low volatility funds like SPLV are handily ahead of both SPHB and SPY over a year or longer. The reason - SPLV doesn't spurt ahead in big leaps but its dips are much less pronounced. see the Yahoo Finance chart below. Slow and steady wins the race, huh?
Though BMO's Canadian equity low beta fund ZLB has been growing slowly since its launch in October 2011, I would have thought those return-chasing investors would have leaped on board this performance vs its market cap rival XIU.
Another interesting feature of ZLU, traded in Canadian dollars despite holdings of US traded and US-dollar denominated equities, is that it also comes in a US-dollar version traded in USD on the TSX under symbol ZLU.U. Given that ZLU and ZLU.U are in effect the same fund, just with two different prices, one in CAD the other in USD, it might even be possible to do low cost currency exchange using Norbert's Gambit as described on Financial Webring, which is often done with DLR and DLR.U.
NB I have voted with my money some time ago and own a fair chunk of ZLB and no XIU.
Friday 29 March 2013
Friday 22 March 2013
Budget Shoots Down Tax Advantaged Swap and Forward-based ETFs
Expect to see a few ETFs disappearing in the next few years. The federal budget delivered yesterday by Minister Flaherty announced that the clever conversion of interest into capital gains (or temporarily, return of capital) through the use of forward contracts or swaps would soon become invalid. The Investment Executive article on the proposed measure makes it clear existing funds that have to renew at some point get caught as well. If I am not mistaken, that would cover pretty well all such funds as the prospectuses I have read include a fund termination date, which would require renewal / extension at that time.
Some of the funds whose days would appear to be numbered:
... addendum
Horizons has put out a press release saying its fund HXT will NOT be affected by the tax change. The press release does not mention HXS but it works the same way as HXT as a total return swap. The budget document itself on page 353 of the pdf refers to transactions that change ordinary income into capital gains which HXT as an equity fund does not primarily do, so maybe HXT and HXS will escape. We'll have to keep monitoring to see exactly how this pans out.
... addendum 2
BlackRock says in a press release that the rule change will affect several of its funds - CAB, CVD, CHB, CHB.U, CYH, CBR, CMF and CMF.A
Some of the funds whose days would appear to be numbered:
- all of the former Claymore, now iShares, Advantaged ETFs that Canadian Couch Potato listed and described here.
- various Horizons ETFs like the Horizons S&P/TSX 60™ Index ETF ( symbol: HXT), which I will need to remove as the Canadian equity component from my cap-weight portfolio contest at the bottom of this page, and the Horizons S&P 500® Index (C$ Hedged) ETF (HXS)
... addendum
Horizons has put out a press release saying its fund HXT will NOT be affected by the tax change. The press release does not mention HXS but it works the same way as HXT as a total return swap. The budget document itself on page 353 of the pdf refers to transactions that change ordinary income into capital gains which HXT as an equity fund does not primarily do, so maybe HXT and HXS will escape. We'll have to keep monitoring to see exactly how this pans out.
... addendum 2
BlackRock says in a press release that the rule change will affect several of its funds - CAB, CVD, CHB, CHB.U, CYH, CBR, CMF and CMF.A
Wednesday 20 March 2013
Smart Beta vs Cap-Weight Investing - No Longer "Whether" but "How" to Do It
The EDHEC-Risk Institute's March 2013 paper Smart Beta 2.0 contains much worthwhile info for the individual investor:
In the free-for-all that the ETF space has become, it is perhaps understandable that ETFs using index weighting schemes other than the traditional market value capitalization-weighting, such as indices based on fundamental accounting factors or low volatility, will get dismissed as mere marketing gimmicks. And there is that danger since, as the paper also points out, the alternative index construction methods and past data are not available to all to probe and test. EDHEC itself is a pretty thorough impartial prober and they show that details like the exact month chosen to rebalance or reconstitute an index can make a lot of difference to performance in any given year. If the complete index rules are not available, they say it's impossible for an investor to make an informed choice or for others to figure out if the past outperformance is likely durable or just a one-off result from cherry-picking a certain time period, for example. They show that the outperformance of fundamental weight indices is mostly, but not all, explained by the Tech bubble when it would have avoided the crazy Internet stocks. That may cause some to dismiss fundamental weight ETFs, though for me, avoiding buying into the next bubble stocks and profiting from the crash, is an attractive idea.
Thanks to Ken Kivenko for the link to the Smart Beta paper.
- Smart Beta index investing beats cap-weighting; (Smart Beta is an umbrella term for various alternative stock selection and weighting schemes, such as equal weighting, fundamental accounting factors or low volatility); there is little or no doubt amongst academics about the inferior efficiency - return bang for risk buck - of cap-weighting (e.g. their comments on page 5) and almost half of institutional investors have adopted an alternative index scheme. That cap-weighting isn't the best doesn't deny financial theory about an efficient market - a footnote tells us "... the efficiency of the benchmark is moreover totally independent of the existence or otherwise of an efficient market ..."with a reference to another of their papers on that point.
- Smart Beta 1.0 indices, upon which present-day ETFs are based, can be improved upon - thus the 2.0 in the paper's title. The authors state that biases and tilts with the alternative indices, which they call systematic risks of the Smart Beta indices, can be corrected and removed while still maintaining almost all of the outperformance - e.g. the small cap bias of a low volatility index can be removed by restricting stock selection to the largest cap stocks. Magic! The sector bias to utilities can be largely removed by constraints on the holdings in that sector. Maybe we cannot buy 2.0 ETFs yet but to me this presents a method for building a reasonably efficient portfolio of individual stocks e.g. pick low volatility large cap stocks while ensuring sector balance.
- Smart Beta 1.0 indices and the ETFs based on them (like some of my favorites with symbols PXC, ZLB, PRF, PDN, RSP) have in the past, and likely also will in future, despite outperforming in the long run, experience periods of 2-3 years of underperformance vs a cap-weight index. On top of that, the worst lag in performance, what they call relative drawdown, can reach 12-13% as the table below copied from the paper shows. That will certainly test an investor's confidence and resolve but proper expectations are a significant help to weathering that psychological storm. In fact, the authors recognize the "dare to be different from your peers" risk as a major obstacle for institutional investors. Fear not the EDHEC wizards propose a solution to this risk by techniques that they show can reduce the tracking error difference with the cap-weight benchmark by about half, again without eliminating the outperformance, though there is a much bigger performance hit than for the bias adjustments.
- Alternative indices have different factors, which EDHEC calls specific risks, that could make them (or the ETFs based on them) not work in the future. Some indices depend on correctly estimating one or more of return, volatility or correlation to outperform, a kind of garbage-in garbage out problem (such as fundamental weighting or low volatility) while others don't estimate anything but may turn to be a very inefficient portfolio, such as equal weighting (and cap-weighting). It's a trade-off - a good model with possibly poor inputs or a crappy model requiring no inputs. Now here is what to me is a significant practical message - they find that diversifying this risk through a mix of alternative weighting schemes outperforms (in a return vs risk sense as expressed by a significantly higher Sharpe ratio) any single method. In other words, for Canadian equities we should hold a 1/3 each mix of low volatility ZLB (or TLV or XMV), fundamental-weighted PXC and equal-weighted HEW.
In the free-for-all that the ETF space has become, it is perhaps understandable that ETFs using index weighting schemes other than the traditional market value capitalization-weighting, such as indices based on fundamental accounting factors or low volatility, will get dismissed as mere marketing gimmicks. And there is that danger since, as the paper also points out, the alternative index construction methods and past data are not available to all to probe and test. EDHEC itself is a pretty thorough impartial prober and they show that details like the exact month chosen to rebalance or reconstitute an index can make a lot of difference to performance in any given year. If the complete index rules are not available, they say it's impossible for an investor to make an informed choice or for others to figure out if the past outperformance is likely durable or just a one-off result from cherry-picking a certain time period, for example. They show that the outperformance of fundamental weight indices is mostly, but not all, explained by the Tech bubble when it would have avoided the crazy Internet stocks. That may cause some to dismiss fundamental weight ETFs, though for me, avoiding buying into the next bubble stocks and profiting from the crash, is an attractive idea.
Thanks to Ken Kivenko for the link to the Smart Beta paper.
Wednesday 13 March 2013
H&R Block Tax Software Giveaway Winners!
The random draw for the H&R Block online tax preparation software contest announced last week has been done and the winners are:
- Traciatim
- Jade
- M
Decling Decision-making ability - It's not age, it's disease that matters
"Age is not a disease"
Note for the regulatory folks like the Ontario Securities Commission, the Canadian Securities Administrators, etc > "... policies aimed at protecting those most vulnerable to poor decision-making should focus on disease, rather than age itself, as a risk factor". To which I would add, in particular, dementia and Alzheimer's, the disease that will become more and more prevalent in seniors. Throwing a big protective blanket over seniors, 87% of whom (among those 65+) are cognitively healthy according to the National Institute of Aging as cited in the study, would be un-necessarily broad. But for the cognitively diseased segment, whether over or under 65, I would guess present protection isn't sufficient. Worsening financial decision-making is often a sign that cognitive impairment may be starting.
The study also offers a hopeful message. We can help ourselves by paying attention to and cultivating two key skills that they found improves decision-making: 1) Strategic Learning (the ability to determine and use a strategy to sift more important information from less important information); 2) Conscientiousness (being careful and organised in regard to finances). We need to exercise our brains, just like our muscles, to keep them strong.
How exactly that can be accomplished, that's not addressed, but the study authors claim so - "prior research has also shown that short-term intensive brain training can strengthen and even restore abstract thinking and strategic learning capacity in cognitively healthy adults". (Some healthy brain suggestions at The Science of Learning blog: healthy food; physical exercise; practising the activities you want to be good at, like music or, ta-da - managing your finances and investments! ... but not watching lots of TV or incessantly playing video games)
It's not just Warren Buffett as an old fart who's rather good at financial decision-making. The Forbes list of billionaires on Wikipedia seems to have a strong preponderance through the years of over 50s, 60s, 70s and 80s, all of whom seem to be vastly increasing their wealth year by year instead of frittering it away.
Tuesday 12 March 2013
CPPIB Investment Turns to Private Deals and Infrastructure
The other day I read RetirementAction Peter Benedek's explanation of why he decided to take his CPP pension at 65 instead of his original plan of 70. One of the points he makes is that CPPIB's investments are becoming increasingly opaque and therefore riskier due to a shift to private deals, since they are hard to value. The fact of the shift is undeniable (they say it themselves at CPPIB), the question is whether risk is actually higher. Consider this brief video interview conducted last September by McKinsey with CPPIB CEO Mark Wiseman. In it he describes how CPPIB looks at private infrastructure deals like buying a toll road as buying into a quarter century of cash flows from sticking with the investment through its full life and not as an opportunistic trading asset to flip for a quick profit. In that perspective, the risk becomes whether CPPIB has done its homework so that projected cash flows actually happen and whether the governance and supervision mechanisms of the CPPIB prevent too much capital ending up in any one holding or connected groups of holdings. In contrast as well, I wonder if any mutual fund held in the average RRSP would take the same view, given the pressure to show annual performance in order to promote themselves and collect or keep assets. I dunno about others but I don't find the CPPIB's private infrastructure deals too troubling.
Wednesday 6 March 2013
H&R Block Tax Software Giveaway
Now that RRSP season is over, it's time to start thinking of preparing a tax return for 2012 even though the deadline for submission is a seemingly distant April 30. The Canada Revenue Agency's NETFILE online tax submission service is open for
business and the CRA is ever more enthusiastic to receive the return via electronic means instead of on paper.
Thanks to H&R Block, I am giving away three codes for the online web version of their personal tax preparation software for Canadians. That's a value of $13.95 up to March 13 and $15.95 thereafter.
Here are the details of the giveaway:
Thanks to H&R Block, I am giving away three codes for the online web version of their personal tax preparation software for Canadians. That's a value of $13.95 up to March 13 and $15.95 thereafter.
Here are the details of the giveaway:
- To enter submit a comment on this post below - though you don't have to, I'd be interested in your comments on tax prep software since I am again working on my annual review of all the CRA NETFILE certified packages (last year's review here); use a unique name (Anonymous won't suffice!) so I can distinguish people
- One entry per person please
- Entries close Tuesday, March 12th midnight EST
- I'll do a random draw of three (3) names from amongst the entries after the deadline
- Winners will be announced on the blog and asked to contact me via email with their own email address so I can reply with the code to enter in the H&R Block tax software (your email will not be used for any other purpose than to contact you as a winner)
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