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):
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