If you are new to the markets, don’t have the time to do proper due diligence, or if you simply want a passive investment strategy, there is perhaps nothing better than index investing. What is Index investing, and why should we be buying index funds?
Simply put, index investing is a passive strategy that attempts to replicate the returns of a particular index. This is done through the purchase of exchange-traded funds (ETFs), or mutual funds that are built to closely track the underlying index. It is also one of the most effective ways to diversify your holdings.
For this particular article, we will be speaking on index ETFs only, as we believe they are more beneficial than mutual funds
Index investing is one of the simplest investing strategies, and one that is recommended by financial gurus. Here is what some of the most well-respected gurus have had to say on the subject:
“By periodically investing in an index fund, for example, the know-nothing investor can actually outperform most investment professionals. Paradoxically, when ‘dumb’ money acknowledges its limitations, it ceases to be dumb.” – Warren Buffet
“The word passive does a disservice to investors considering their options. Indexing provides an effective means of owning the market and allows investors to participate in the returns of a basket of stocks. The basket of stocks changes over time as stocks are added or removed based on its rules.” – Charles R. Schwab
Research has shown that retail investors consistently underperform the markets. In fact, most hedge funds do as well. At the heart of the issue for retail investors – is emotions. Index funds take the emotion right out of the equation, as investors don’t get emotionally attached to any particular stock or company.
With this in mind, let’s take a look at the top Canadian ETF Index funds that provide a low-cost and passive investment solution for investors.
BMO S&P/TSX Capped Composite Index ETF (TSX:ZCN) & iShares Core S&P/TSX Capped Composite Index ETF (TSX:XIC)
|1||Royal Bank of Canada||6.49%|
|4||Bank of Nova Scotia||3.81%|
|6||Brookfield Asset Management||2.95%|
|7||Bank of Montreal||2.72%|
|9||TC Energy Corp||2.61%|
Let’s start with the ETFs that cover the broadest collection of Canadian stocks, the S&P/TSX Capped Composite Index. I’ve listed two – the BMO and iShares versions. In essence, both are pretty much identical and have very similar compositions.
Both track the performance of the S&P/TSX Capped Composite Index which covers approximately 95% of the Canadian equities market, and has been the primary gauge for Canadian-based, Toronto Stock Exchange-listed companies since 1977.
The ETFs have identical MER fees (0.06%) and have similar holdings. The iShares fund is slightly larger with $5.8 billion in assets as compared to the $4.1 billion held by the BMO fund.
Since this is a capped index intended to represent the broader TSX, the sector weightings are largely inline with the broader market. As such, Financials, Energy, Industrials and Basic Materials dominate the portfolio holdings.
The Top 10 of each ETF accounts for approximately 37% of the assets and features several of the big banks including…
- Royal Bank of Canada (TSX:RY)
- Toronto-Dominion Bank (TSX:TD)
- Bank of Nova Scotia (TSX:BNS)
- Bank of Montreal (TSX:BMO)
Other notable names include…
- Enbridge (TSX:ENB)
- BCE (TSX:BCE)
- Suncor (TSX:SU)
If you are looking to closely track the TSX Index, these two ETFs are your best options.
iShares S&P/TSX 60 Index ETF (TSX:XIU)
|1||Royal Bank of Canada||8.31%|
|4||Bank of Nova Scotia||4.87%|
|6||Brookfield Asset Management||3.77%|
|7||Bank of Montreal||3.48%|
|9||TC Energy Corp||3.34%|
The iShares S&P/TSX 60 Index ETF tracks the 60 biggest stocks on the TSX Index. These are defined as the biggest in terms of market cap and are considered the most liquid stocks on the index.
This ETF is one of the largest in the country with net assets of $9.2 billion and pays out a quarterly distribution that currently yields 2.88%. XIU has a moderate risk profile and ultra-low MER fees of 0.18%.
The iShares Index ETF has done particularly well over the past number of years. It has outperformed the Canadian Equity fund category over the past one, three, five and ten-year periods. In other words, it has consistently outperformed the broader TSX Index.
In 2019, the Index ETF gained 21.96% outperforming the broader TSX Index (18.33%) and the Canadian Equity fund group (20.05%).
The top 10 stocks account for approximately 47% of the portfolio and the industry weightings closely match that of the index weightings as Financials and Energy dominate the portfolio.
In fact, if you look closely, the Top 10 holdings are identical to that of the two previous ETFs which tracked the S&P/TSX Capped Composite Index. The difference being, that the top 10 account for a bigger percentage of assets as there is a smaller number of stocks.
Simply put, XIU is the best blue-chip ETF on the market.
S&P/TSX Canadian Dividend Aristocrats Index Fund (TSX:CDZ)
|1||Exchange Income Corp||3.53%|
|3||Alaris Royalty Corp||3.34%|
|4||Inter Pipeline Ltd||2.75%|
|6||Capital Power Corp||2.28%|
|9||Choice Properties REIT||2.08%|
There is only one ETF that currently tracks Canada’s Dividend Aristocrats. In comparison, there are almost a dozen funds south of the border that track U.S. dividend growth companies.
Aristocrats are stocks that have a history of raising their dividends for at least five consecutive years.
The index fund seeks to replicate the investment of the S&P/TSX Canadian Dividend Aristocrats Index. To be included in the Index fund, stocks must have a market cap of at least $300 million. There are currently 82 stocks in the portfolio. It is one of the simplest ways to implement a dividend growth strategy.
The fund has MER fees of 0.60% and pays out a monthly dividend that currently yield’s 4.02%. Since 2014, the company has raised eligible dividends from $0.76101 to $1.11098 per share.
This is equal to an average of 9.2% annually. In comparison, the Canadian Dividend Aristocrats have collectively raised dividends by approximately 11.8% over the same time frame.
In 2019, it tracked the performance of the broader TSX Index (+19%) and it has outperformed the Canadian Dividend & Income equity category average over the past three, five and ten-year periods.
Over the past 10 years it has averaged a compound annual return of 8.28%.
The Aristocrat index fund is a well-balanced ETF with most sectors accounting for no more than 20% of holdings. The lone exception is Financial Services which is the top sector holding at 20.40%.
The Top 10 holdings are quite interesting and outside of the norm. They account for only 25% of holdings and no stock accounts for more than 4% of holdings.
Exchange Income Fund (TSX:EIF) is the top holding, following closely by TransAlta Renewables (TSX:RNW), a Canadian renewable energy company, neither of which make the top 10 in any of the other funds covered. Likewise, the top banking stock is Laurentian Bank of Canada (TSX:LB) which is also a rarity.
iShares S&P/TSX Capped Info Tech ETF (TSX:XIT)
|2||CGI Inc Class A||23.80%|
|4||Open Text Corp||14.03%|
Over the past decade, the TSX Index has underperformed the U.S. markets in a fairly significant way. The main reason? Exposure to technology.
Information Technology accounts 5.2% of the TSX Index.
Although this is up significantly from years past, it pales in comparison to the exposure south of the border. Information Technology is the top weighted sector accounting for 22% of the S&P 500.
As mentioned, Canada is starting to form an impressive collection of IT companies.
As such, now is the perfect time to look at the iShares S&P/TSX Capped Info Tech ETF. The ETF attempts to replicate the performance of the Canadian Capped Information Technology index and has MER fees of 0.61%.
Given the tech boom, it is not surprising the XIT has been a beast.
In 2019, it returned 51%, crushing both the TSX (18.33%) and the average of other sector equity funds (11.06%). It is a similar story over the past three, five and 10-year periods.
If you are bullish on the markets, expect XIT to consistently outperform.
Interestingly, the top four holdings account for 85.9% of the portfolio. These include Constellation Software (TSX:CSU), CGI Group (TSX:GIB.A), Shopify (TSX:SHOP) and Open Text (TSX:OTEX). Combined, the top 10 account for 98.83% of assets.
This lack of diversification is a reflection of a young industry. As mentioned, tech hasn’t had a big presence on the TSX and it has only recently begun to expand. This is a highly concentrated ETF appropriate for those with a higher risk appetite, and for investors looking to capture the best of the best, TSX-listed technology companies.
iShares Core S&P U.S. Total Market Index ETF (TSX:XUU)
|4||Alphabet Inc C||1.28%|
|8||Alphabet Inc A||1.27%|
|9||Johnson & Johnson||1.18%|
|10||Visa Class A||1.04%|
One of the biggest mistakes made by Canadian investors is lack of exposure to markets outside of the country. The TSX Index is heavily weighted towards financials and is highly dependent on resources.
Considering this, investors should add exposure to equities south of the border.
The iShares Core S&P U.S. Total Market Index ETF is the best and most diversified way to accomplish this. It trades in Canadian dollars, and aims to track the performance of the S&P.
It is a relatively young ETF having only been introduced in 2015. Over the past one and three-year periods it has outperformed the S&P 500 by a couple of percentage points.
Outside of significantly increasing diversification, it has ultra-low MER fees of 0.07%. It is worth noting however, that his is slightly misleading (more on that later).
The Top 10 securities account for only 18% of assets, and there are 3,436 stocks in the portfolio, a testament to its diversification. Not surprisingly tech dominates the top 10 with Microsoft, Apple and Amazon leading the way. Berkshire Hathaway and Johnson & Johnson also crack the top 10.
There is no better way to increase your exposure to the stock markets south of the border. A word of caution however, the ETF is subject to withholding taxes. Since the XUU holds underlying ETFs, it faces a withholding tax of 0.32% regardless if it is held in an RRSP. This has the net effect of bumping its MER to 0.39%. Still cheap, but not as eye-catching as an MER of 0.07%.