TD Waterhouse Offers International Trading - Partly Good, Partly Bad

The news that TD Waterhouse (hat tip to Wealthy Boomer Jonathan Chevreau's post today) is offering the ability to trade directly on major international stock exchanges is mostly good - international diversification becomes a little easier. Canada is catching up to the UK, where TDW has offered such a service for years now.

I guess the small matter of the financial crash of 2008 somewhat delayed the implementation of TDW's intention announced by the Globe and Mails's Rob Carrick as I posted about two years ago, almost to the day.

But TDW is charging too much. Why is TDW charging Canadians £29 commission per trade (see TDW Canada Online Commissions and Fees) for buying shares in the UK when TDW UK's commission is less than half at £12.50 (rate table here)? The same higher cost applies to the other foreign markets too. Give us a break TDW!

Update Sept.16: TDW says blandly in an email reply to my enquiry that the higher commission fees in Canada are "...reflective of the greater underlying costs..." and that they are "competitive". I guess the Canadian operation of TDW isn't as efficient as it is in the UK. TDW also says the online Global Trading capability cannot be used in registered accounts, another difference with the UK where it is possible to trade on international exchanges in the similar ISA account.

Which Online Broker to Choose?

Online brokers vary quite a bit in their features and services, so choosing the one that is best for you out of the fourteen available may require some comparison shopping. Here's my suggested shopping list.

1) Does the broker offer all the Account types (RRSPs/RIFs, RESPs, LIRAs/LRIFs, Trust accounts) and choice of Securities (mutual funds, fixed income) you need?

2) Are Fees and Commissions competitive? Compare:

• trading fees / commissions - the cost per share or per trade for buy/sell transactions; the rate may be much lower with a larger account balance
  
• administration fees - for account balances below a minimum size, there is often a quarterly or annual charge
• bond commissions - you pay a commission buried in the price when buying and selling bonds as Rob Carrick of the Globe and Mail explains; it's hard to compare brokers for that reason but see some of the blogs below for discussion
• foreign exchange - when trading US stocks or bonds it is necessary to convert to/from Canadian dollars; the broker will do it for you but you pay an implicit commission through the exchange rate charged. Within registered accounts like RRSPs, a few brokers allow you to keep a US dollar cash balance, which is advantageous if you intend to sell a US stock and then buy another since you avoid a round trip through Canadian dollars with a commission on each leg of that round trip.

3) How much will you need Tools and Research like stock data, news feeds, analyst reports, sorting and ranking tools and personal financial planning aids such as investor education documents, retirement planners, asset allocation and portfolio design tools?

4) Have a look at each broker's website to see if the Website Interface and Usability will make it frustrating or easy to invest.

5) Happily, Online Security and Investor Protection are uniformly good enough all round in my opinion to remove those as make-or-break worries about brokers.

6) Is live telephone Customer Service there when you need to fix problems with minimum hassle or carry out special non-automated transactions? Opinions on the brokers vary, so read the blogs and newspaper reviews and take none as the ultimate answer.

7) Are you best with a Best-of-Breed broker or One-Stop-Shopping?
The independent brokers may have the lowest per share trading costs but the banks offer online integration with banking, simplifying tracking of investments and enabling quick movement of money among accounts.

Assessments and Ratings

• Stingy Investor has a list of Canadian discount brokerages with their trading commissions and links to the broker websites.
• Canadian DRIP Primer has a more up to date list of Canadian discount brokers.
  
• Canadian Capitalist briefly reviews many of the brokerages in linked posts
• Million Dollar Journey compares online brokers, focusing on the independents
• Rob Carrick of the Globe and Mail rated online brokerages back in Oct. 2007

I've been a client of BMO Investorline for over ten years and though they aren't perfect (US dollars in registered accounts please!), I've discovered that the others are not either. BMOIL does a very competent job for me and I can recommend them. I also have an RESP account with TD Waterhouse, where I've had a generally positive experience.

Finally, if you sign up with a broker and they don't serve you well, you can transfer to another broker.

TD Waterhouse to Offer Online Trading on Global Markets

Rob Carrick spilled the good news in his article Against the Tide in today's Globe and Mail that TD Waterhouse will begin offering online trading in European markets followed by the Far East this fall. Excellent!

This capability has already existed for some time in their UK service, while in Canada, so far as I know, only HSBC InvestDirect currently offers global trading. Hopefully, other discount brokers will follow suit, further enabling international diversification by DIY investors.

The Impossible: Buying US Mutual Funds in Canada

A reader asks this question:
"I am currently setting up an RRSP for my daughter who plans on providing small monthly contributions. ETF's seem out of the question because of the monthly transaction costs associated. Vanguard index mutual fund for american and international exposure seemed like a good idea since their MER's are so much lower than comparable Cdn products. However my broker (TD ) tells me that they don't offer this. Are you aware of anyone in Canada that does? Any suggestions?"

Maybe your broker should have said instead that it is illegal for US funds to be sold in Canada. All funds must be licensed / registered with the provincial securities commission, e.g. the Ontario Securities Commission, and file a prospectus with it. So I believe Vanguard could theoretically be sold in Canada if it went through all the legal rigmarole of registration and licensing but it hasn't so far. I tried quickly without success to find a link to the actual regulation on the OSC website, though I came across this snippet from another document that confirms the situation:
"Policies that prevent US mutual fund companies from soliciting business in Canada, forbid advisors to recommend US funds to Canadian clients, and prevent the distribution of US mutual funds without filing a prospectus in Canada, all serve to protect the Canadian mutual fund industry. Severe tax consequences also deter Canadian investors from investing in US mutual funds." Source: letter to OSC, Re: An Alternative Trading System, Oct.13, 1999 (I believe the last sentence may refer to the fact that income received from US funds would lose their tax-advantaged character as dividends, or capital gains)

The other alternative of opening an account with a US broker used to be possible years ago but has been shut down by the US authorities - see this (justified) rant by ByloSehi. Sadly, you must forget those great Vanguard mutual funds.

You are aware of the Vanguard ETF option and its limitations for your situation. Perhaps you could accumulate the cash in the TD RRSP in a money market mutual fund to gain a little interest and get the RRSP deduction as well as the regular savings in operation. Once or twice a year you could buy the ETF to minimize the trading fees. I'd also check out brokers like Questrade that offer lower trading fees even for small accounts.

Another option would be to buy TD e-Series (Internet only) mutual funds for a few years. Their fees aren't great but at around 0.48% are not nearly as high as most Canadian mutual funds. After accumulating $20-25k, you could then switch to ETFs. Who knows, by then Vanguard may have expanded to Canada or the Canadian funds may have substantially lowered their fees (both of which are likely to occur at the same time ... call it the Walmart effect)?

I leave you with this statement from the same letter (see p.3) linked to above:
"The result of Canadians being denied access to the US mutual fund industry is the existence of a healthy and productive mutual fund industry in Canada that benefits the Canadian economy." ... but not the Canadian consumer / investor!

Bond Index ETF/Funds vs Bond Ladder

A little while back, Mike from QFP asked me to compare my experience using a bond ladder for the fixed income component of my portfolio versus bond funds, which I have just started using this year in the form of ETFs. Good question, here are my thoughts.

Bond Ladder
My holdings look like this:

• More than ten individual bonds;
• Different issuers, corporate only, none government, Canadian only, no foreign;
• Staggered Maturity approximately (at various times throughout the calendar year) one year apart, from 2008 up to 2026
• Held across two LIRAs and an RRSP
• No buy-sell, just buy and hold to maturity - when one matures I buy at the long end of 10+ years which gives higher yield - since I've been doing this, the yield curve hasn't gone upside down, where higher yields would be available for shorter term bonds
• Coupon bonds only, no strips or residuals
• Investment grade only

Observations:

1. Credit risk and diversification is merely ok but not great - I have too few bonds in too few categories to be properly diversified. Though I have bought only investment grade bonds, it happened once that one company had its debt rating lowered and the price took a big hit. It didn't actually go into default but that risk isn't negligible. I didn't lose any money because I held to maturity and the bond was repaid at par. A few years back, Telus had a bad patch, it got downgraded, I nervously bought a bit, management got the ship back on track and lo and behold, I made a very nice gain in addition of course to continually receiving the coupon payments. Nowadays, I'm taking the attitude that I won't presume to judge better the credit risks than Standard & Poors or Dominion Bond Rating Service.
   
2. Portfolio rebalancing is more difficult - since I have made myself a policy to rebalance my overall investment portfolio back to target percentage allocation (30% in fixed income) if it comes to pass that equities have a crappy year and I am overweight in fixed income, what should I do - which bond to sell and put a hole in the ladder? As well, bond buy-sell minimums might cause an asset allocation overshoot and the buy-sell spread/commission on bonds adds to costs.
3. Purchases are lumpy - the minimum bond purchase amount is $5,000 so you need a fairly hefty sum to even build a ladder. The smallest I have seen suggested is a ladder of five bonds, i.e. $25,000, though due to the above diversification considerations, I feel $50,000 is more like a proper minimum.
4. Limited inventory - the discount brokers don't have a huge selection. Yesterday, when I went through my TD Waterhouse account there was not a single corporate bond of more than eight years maturity. BMO Investorline had a much better inventory, but ...
5. Commissions can vary between discount brokers - I managed to find the same bond for sale at both BMOIL and TDW yesterday and discovered that BMOIL charges a higher commission than TDW. The GE Capital 4.4% 01JUN14 ask price for the min $5k purchase at BMOIL was 96.46 and 96.257 at TDW, a difference in commission of about 1% vs 0.76%. BMOIL = bigger inventory but higher commissions. TDW also supplies, very conveniently, both the bid/buy (94.757 in this case) and ask/sell prices, which is what allowed me to figure out the mid/average price and the commission.
6. Commissions and therefore costs can be low if bonds are held to maturity - though the commission on an equity trade of $10/5000 = 0.2% is much lower than the above bond example, there is no recurring admin or management cost on the bond and, if held to maturity, the cost averaged over years goes down to very small amounts, which Shakespeare's primer has conveniently calculated and graphed here. On the other hand, if you start actively buying and selling bonds, your commission costs will be quite high, i.e. my recommendation is that a bond ladder is for holding bonds to maturity.
7. Commissions do drop with larger purchases and your yield/return rises. For example, today on BMOIL, buying $100,000 of GE Capital DD Call 4.65% 11FEB15 gives a yield of 5.238% while the minimum purchase of $5,000 yields 5.117%, a difference of 0.121%. As they say here, every little helps. Do you have $1mill for your bond ladder to get that extra 0.1%? No? Then just buy another bond that yields slightly higher.
8. Choice of receiving the return as cash or an ultimate lump sum. Most bonds pay out cash as coupon interest payments every six months, though some do so every month, allowing one to tailor a cash flow if desired. In my case, I really should be buying stripped coupons and residuals instead of regular coupon bonds to avoid having the interest payments sitting idly in cash between my rebalancings and to lock in the yield aka avoid the reinvestment problem. (A really good brief explanation of stripped bonds is BMOIL's on their website at https://www1.bmoinvestorline.com/EducationCentre/FixedIncome/Products.html#3.1 or if you cannot access that page, see Shakespeare's explanation at the link above. I am still accumulating and not withdrawing from my registered plans so I don't want cash, but someone else in retirement and needing to withdraw cash might find that handy.
   

Bond ETFs

1. Diversification is easy and assured. With one purchase it is possible to acquire a large number of bonds to cover the whole Canadian market, like XBB, or subsets thereof to reduce individual company credit risks to their minimum. One can acquire a subset that apparently acts as a separate un-correlated asset class - real return bonds, like XRB. One can also buy foreign bonds, like the US dollar AGG, which I have done to further diversify my holdings, or even international bonds, though I have not done that yet. Read this GlobeInvestor article for a rundown of various US and international alternatives.
   
2. Rebalancing is easy and precise. Since the ETFs are like a stock, an asset allocation can be set almost to the dollar and it takes only one trade.
3. Management fees are a bit higher. The annual management fee on a fund, even if it is a passive index-tracking fund like the ones named above, takes a bit away from the return every year. MERs: XBB - 0.3%, XRB - 0.35%, AGG - 0.2%
4. Interest payments on bond ETFs are received in cash, with the same issues as discussed in the case of individual bonds. Bond mutual funds can reinvest the payments but their MERs are higher, which is a worse problem than receiving cash. If you have one giant holding in an ETF and receive a large cash payment, it may be enough to reinvest immediately instead of waiting months while a reasonable amount piles up.

Most of my fixed income portfolio is in the Canadian bond ladder, but I have smaller holdings in some of the bond ETFs mentioned to facilitate my asset allocation and rebalancing. For me, and I would suggest for anyone, tax considerations don't enter into the picture since my holdings are all in tax-deferred registered accounts. It doesn't make sense if one can possibly avoid it, to have any fixed income in a non-registered taxable account - it's always better to pay taxes later.

UK Portfolio - Part 2 - Principles & Constraints

Before taking any actions and making any decisions regarding the revamping of the portfolio of my UK friend, it is important to spell out the principles and constraints that will drive the portfolio and its management for the indefinite future. So here they are:

KISS (Keep It Simple Stupid) - The over-riding organizing principle is that the portfolio and its on-going management should be as simple as possible. In the immortal words of Albert Einstein who seemed to have mastered KISS with his famous formula, "Everything should be made as simple as possible, but not simpler." Simplicity is in keeping with the desire of the person owning the portfolio to not spend large amounts of time on managing it. The principle will also enable the owner to understand and to track the portfolio and to make the changes without intervention by anyone else.

Consistent with Financial Theory - The portfolio should accept and adhere to the results of the massive amount of financial research, i.e. that is scientific and generally accepted, conducted in the last 80 years. Perhaps this is too obvious to state but it dictates that market timing be avoided and that diversification be pursued. A standard finance textbook like Bodie et al, Investments, is a good source for seeing what is generally-accepted.

Passive Investing with Index ETFs or Funds - The portfolio will therefore take a passive investing approach, rather than active management, and this includes avoiding ETFs or funds that have active managers. Financial theory says that one cannot and should not try to beat the market so buying the market in the form of funds that track the market is the way to go.

Low Number of Holdings - Too many different holdings will add to confusion and will make it more cumbersome and difficult to do the required re-balancing, especially across the four account types that will need to be used for tax reasons. On the equity side, that arbitrarily will mean no more than ten holdings. This factor is less important than the diversification requirement, which is at the heart of the portfolio approach. Thus, if effective diversification had required more than ten holdings, the number would have to be bumped up. Fortunately, this is not the case. There was a certain iterative process I found in doing this whole exercise where the initial objectives and principles needed to be reviewed and somewhat revised when later steps showed something didn't work quite right and slightly revising an earlier decision made it all fit better.

Implementable / Investable - A good example of this iterative revision happened when I tried to later on find the actual ETFs/funds to purchase for the portfolio and discovered that the UK doesn't have anywhere near the depth and breadth of choices in ETFs or low-cost funds that a Canadian can buy in the US market. UK discount brokers generally don't offer the ability to buy such US-traded funds, with the result that some particular holdings like international value and small cap ETFs are simply not readily available to UK investors. I eventually did come across TD Waterhouse UK, which does offer an account that enables full, direct access to US exchanges (NYSE, Amex, NASDAQ) but by then implementation had already started with another brokerage and it would have been a lot of bother to back and start over. It has been said many times that an imperfect plan properly executed now is better than a perfect plan next month.

Long Time Horizon - The investment assumption for the most part is an investment horizon of many years, twenty or more. That's because the person has a salary more than adequate for today's needs, and a pension that will be sufficient to live off without this portfolio's profits. It will be possible to be patient to ride out the inevitable downs of multi-year equity market dips. As Moshe Milevsky notes in his books and articles, time in retirement can easily reach 25-35 years so that's a good investment planning horizon for this person. The reference to the "for the most part" is the possibility that there will be a desire to help out a child financially, for example, to assist making a housing purchase in the very pricey UK market. That explains why in the preceding Diagnosis post, a fairly high allocation in liquid cash was deemed ok.

Tax Minimization - This is a goes-without-saying objective. A guaranteed tax saving is like an extra risk-free return. Not paying 20% tax on interest-bearing investments increases the after-tax net return by that amount. Putting money into tax-exempt accounts/plans like an Individual Savings Account (see here for how they work) or holdings, like tax-exempt bonds (see National Savings and Investments) within the overall portfolio plan, will be pursued in the revamping.

Cost Minimization - Perhaps not as obvious as minimizing taxes, but paying high annual fees on the 1.5% on the existing funds is to be avoided if possible. A target would be 0.5% as desirable and under 1% the maximum. It has been shown that, on average, higher cost funds produce lower returns for the investor (though I cannot find the link as a reference at the moment). The same goes for brokerage account management and trading fees, though the impact is less (unless one would go to a full service broker who charge a percentage of the assets held). A simple portfolio that can be self-managed on-line lends itself well to lower cost discount brokerages.

Annual Re-balancing - The portfolio will be re-balanced once a year in mid-April. The asset allocations will be re-stored by selling and/or buying the same ETFs or funds already in the portfolio. If there is only a small deviation of the order of less than 1% from the total portfolio target a holding will be left alone. The annual re-balancing frequency has been chosen because research such as here at the Journal of Financial Planning and here at William Bernstein's website indicates it gives close to the best investment results vs risks. Once a year, after tax year-end of April 5th here in the UK, is a convenient time to move investments or put new money into the tax-exempt ISAs. Finally, it becomes a file-and-forget item that makes it easy for this well-organized person to schedule into the agenda.

Diversification - The single most critical element is that the portfolio will seek diversification benefits of higher returns and lower volatility. This is accomplished by selecting holdings that are either uncorrelated or negatively correlated with each other (see explanations such as IndexInvestor.com, and William Bernstein, linked above plus books like that of Richard Ferri which I previously reviewed). This apparently is not an exact or perfect science since such correlations vary considerably from year to year and for many years diverge from long-term averages but the benefit is very considerable over long time periods when such variations even out (thus the importance above of adopting a long planning horizon). That means acquiring holdings among equities in real estate, in small cap companies, in value (i.e. measures of "cheap stock price" according to accounting stats) companies and in international markets.

Investing in Canadian vs International Equities

Just came across a fascinating article on the CTV website titled "The identity crisis that will change the TSX" that was published in Saturday's Globe and Mail. Midway through it is a key phrase - "the Toronto Stock Exchange is becoming a market of smaller companies clustered in a narrow range of industries". The narrow range works out to financial, energy and mining.

The article is another good reminder about the need for Canadian investors, me included, to reduce equity holdings in the TSX to a minor portion - 10% or less - of the equity portfolio.

One of the benefits of moving to Scotland is that the distance adds perspective. It is easier to see how foreigners view Canada and to see Canada in its true place in the world. With respect to investment, Canada is a minor player, valuable primarily as an additional diversification element through resources.

The article also mentions the small cap nature of most of the TSX, so it can also play a small cap role in a portfolio (as we all know, small caps over long holding periods like twenty years, have been shown to give higher returns and to have weak correlation with the overall market, which in turn offers diversification benefit). Martin Gale over at Efficient Market Canada has an excellent article showing how the actual world equity market proportions work out - Canada is just over 3% of the total - and he uses this to show how a truly global portfolio would be structured, even to the names of the funds to buy. The reassurance of investing in what one knows about - domestic companies - is a great hazard as a result of the extra risk through inadequate diversification. (It's the same here in the UK. I'm in the midst of helping a friend do a portfolio makeover and that portfolio was 100% in UK equities yikes! ... through a raft of different mutual funds yikes! ... more on that in a future post).

Since I was due to do my semi-annual portfolio re-balancing in May, I will be doing some fairly drastic re-allocations along these lines, about which I will be posting down the road.

In my poking around thegoodwebguide.co.uk review of UK online brokerages, I came across TD Waterhouse, the UK version. It offers what seems to be a wonderful account for those interested in international investing and diversification. Through one account, it is possible to trade directly on 15 different exchanges around the world, including Canada, the USA, the UK, various other European exchanges, Australia, Hong Kong and Singapore. In addition, the holdings can be in four different currencies - Canadian and US dollars, sterling and euros. The trade costs are not the lowest at £12.50 for online trades (around CDN$ 30) but that's a lot better than the $100-200 BMO Investorline had told me a few years ago that it would cost to buy UK securities. Unfortunately the account is only available to UK residents and it doesn't look like TD Waterhouse Canada offers a similar one but it sure looks to me like it would be a smart thing to offer.