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July-22-11

ETF Investing for Beginners: International Equity

In the third blog post of this series, we will look at how an investor can use ETFs to obtain International (including developed and emerging) market returns. Canadians investing abroad must also be aware of how foreign exchange fluctuations can affect their portfolio returns. There are products available that attempt to hedge away this risk, such as the iShares MSCI EAFE ETF (CAD-Hedged) (XIN). This currency hedged ETF could be used in conjunction with the unhedged Vanguard MSCI Emerging Markets ETF (VWO) to replace a portion of the unhedged Vanguard FTSE All-World ex-US ETF (VEU), while ensuring that the portfolio allocation to emerging markets is not diluted. Whatever the percentage amount of international equity that you would prefer to be hedged, simply multiply that amount by 0.35 to obtain the percentage that should be invested in VWO, and then subtract both amounts from your allocation to VEU.

Example:
A Canadian investor would like to place 50% currency hedging on the broad International equity component of their portfolio, while still maintaining the same breakdown between developed and emerging markets (74% and 26% respectively).  The investor currently invests the international equity allocation of their portfolio in the following ETFs:

  • 90% in Vanguard FTSE All-World ex-US ETF (VEU)
  • 10% in Vanguard FTSE All-World ex-US Small-Cap ETF (VSS)

Using the international ETFs discussed above, what would be their new international equity allocation?

  • 50% in iShares MSCI EAFE (CAD-Hedged) (XIN)
  • 17.5% in Vanguard MSCI Emerging Markets ETF (VWO) → [ 50% × 0.35 = 17.5% ]
  • 22.5% in Vanguard FTSE All-World ex-US ETF (VEU)     → [ 90% - 50% - 17.5% = 22.5% ]
  • 10% in Vanguard FTSE All-World ex-US Small-Cap ETF (VSS)

The new portfolio now has 50% of its international currency risk hedged away, while maintaining the 74% allocation to developed markets and 26% allocation to emerging markets.

For more information on currency hedging, please read An introduction to currency and currency hedging, by Mackenzie Investments. 

To obtain broad International equity market exposure, an investor could purchase a combination of the following:

  • 90% Vanguard FTSE All-World ex-US ETF (VEU) – this ETF tracks the FTSE All-World ex US Index, and is comprised of over 2,200 large and mid cap companies across developed and emerging non-U.S. equity markets around the world
  • 10% Vanguard FTSE All-World ex-US Small-Cap ETF (VSS) – this ETF tracks the FTSE Global Small Cap ex US Index, and offers broad exposure to over 2,500 mid and small cap companies across developed and emerging non-U.S. equity markets around the world. 

Broad international equity market exposure could also be obtained by investing 100% in the Vanguard Total International Stock ETF (VXUS), which tracks the MSCI All Country World ex USA Investable Market Index, and offers exposure to over 6,000 large, mid, and small cap companies across developed and emerging non-U.S. equity markets around the world, with an MER of 0.20%.

Depending on the investor’s appetite for risk, the allocation to VSS (which is comprised of mid and small cap companies) could be increased. This would increase the portfolio’s risk as well as expected return.

Once again, depending on the investor’s risk tolerance, a heavier allocation to value stocks could be considered (the definition of “value stock” varies among investors, but it is generally accepted that a high relative book to market ratio for a stock is a strong indicator). Similar to smaller capitalization stocks, adding more value stocks to the portfolio will increase the portfolio’s risk as well as the expected return. In the example to the left, iShares MSCI EAFE Value ETF (EFV) has been added to the mix, which tracks the MSCI EAFE Value Index, and is comprised of developed international large and mid cap value companies.  Since EFV does not include emerging markets, a separate allocation to Vanguard MSCI Emerging Markets ETF (VWO) has been added to account for the overall underweight. 


Source(s):  BlackRock, BlackRock Canada, Vanguard

 

 

 

By: Justin Bender | 2 comments
July-15-11

ETF Investing for Beginners: U.S. Equity

In the second blog post of this series, we will look at how an investor can use ETFs to obtain U.S. equity market returns. Canadians investing abroad must also be aware of how foreign exchange fluctuations can affect their portfolio returns. There are products available that attempt to hedge away this risk, such as the iShares S&P 500 ETF (CAD-Hedged) (XSP). This ETF could be used to replace a portion of another unhedged ETF in your portfolio that tracks the S&P 500 Index, such as the Vanguard S&P 500 ETF (VOO). For more information on currency hedging, please read An introduction to currency and currency hedging, by Mackenzie Investments. 

To obtain broad U.S. equity market exposure, an investor could purchase a combination of the following:

  • 80% Vanguard 500 ETF (VOO) – this ETF tracks the S&P 500 Index, which is widely regarded as the best measure of the large cap U.S. equities market.
  • 20% Vanguard Extended Market ETF (VXF) – this ETF tracks the S&P Completion Index, and offers broad exposure to mid, small, and micro cap U.S. companies. 

The allocations above would approximate the S&P Total Market Index (which offers exposure to over 3,500 large, mid, small, and micro cap companies).  Alternatively, Vanguard Total Stock Market ETF (VTI), which tracks the MSCI US Broad Market Index, could be purchased, with an MER of 0.07%.

Depending on the investor’s appetite for risk, an allocation could be made to the iShares S&P SmallCap 600 ETF (IJR). This ETF tracks the S&P SmallCap 600 Index, which covers approximately 3% of the U.S. equity market. This would increase the portfolio’s risk as well as expected return. 

Alternatively, the original allocation to VXF (which is comprised of mid, small, and micro cap U.S. companies) could be increased.

Once again, depending on the investor’s risk tolerance, a heavier allocation to value stocks could be considered (the definition of “value stock” varies among investors, but it is generally accepted that a high relative book to market ratio for a stock is a strong indicator). Similar to smaller capitalization stocks, adding more value stocks to the portfolio will increase the portfolio’s risk as well as the expected return. In the example to the left, iShares S&P 500 Value ETF (IVE) has been added to the mix, which tracks the S&P 500 Value Index.


Source(s):  BlackRock Canada, Standard & Poor’s, Vanguard

 

 

By: Justin Bender | 0 comments
July-08-11

ETF Investing for Beginners: Canadian Equity

In the first of a series of blog posts, we will look at how an investor can gain access to various equity market returns, using a select number of exchange-traded funds (ETFs). Although PWL uses more efficient, sophisticated products with our clients to obtain these returns (such as low-cost fee-based products offered by Dimensional Fund Advisors Canada ULC), we’ll stick to the plain vanilla ETFs when explaining how portfolios can be tilted towards the three equity risk factors below (which we believe drive market returns over the long-term):

  1. Market Risk (Stocks have higher expected returns than fixed income)
  2. Size Risk (Small company stocks have higher expected returns than large company stocks)
  3. Price Risk (Lower-priced "value" stocks have higher expected returns than higher-priced "growth" stocks)

The goal is to gain a basic understanding of how portfolio construction can incorporate the above equity risk factors to suit each investor’s personal risk preferences. The examples below are in no way intended to be recommendations – the average individual investor may be better off simply buying an individual broadly diversified ETF to gain their Canadian equity market exposure and calling it a day.

 

 

To obtain broad Canadian equity market exposure, an investor could purchase a combination of the following:

The allocations above would approximate the S&P/TSX Capped Composite Index (which offers exposure to over 250 large, mid, and small cap companies). Alternatively, iShares S&P/TSX Capped Composite Index ETF (XIC) could be purchased, with an MER of 0.26%.


Depending on the investor’s appetite for risk, an allocation could be made to the iShares S&P/TSX SmallCap Index ETF (XCS). This ETF tracks the S&P/TSX Small Cap Index, which is comprised of the smaller capitalization companies in the Canadian equity market. This would increase the portfolio’s risk as well as expected return. Alternatively, the original allocation to XMD (which is comprised of mid and small cap Canadian companies) could be increased.


Once again, depending on the investor’s risk tolerance, a heavier allocation to value stocks could be considered (the definition of “value stock” varies among investors, but it is generally accepted that a high relative book to market ratio for a stock is a strong indicator). Similar to smaller capitalization stocks, adding more value stocks to the portfolio will increase the portfolio’s risk as well as the expected return. In the example to the left, iShares Dow Jones Canada Select Value Index ETF (XCV) has been added to the mix, which tracks the Dow Jones Canada Select Value Index.
 

Source(s):  BlackRock Canada, Standard & Poor’s 

By: Justin Bender | 0 comments