ETFs and Funds Investing

Buyer Beware: The Different Types of ESG Funds

The problem is that “ESG” is becoming a catch-all for “doing good”, and this is a big mistake.

As the ravages of climate change become increasingly apparent, investor interest in sustainable investing (aka ESG – Environmental, Social, Governance) is growing at an exponential rate. Seeing this trend, asset managers are launching a ton of ESG products.

The problem is that “ESG” is becoming a catch-all for “doing good”, and this is a big mistake. Investors see brochures with pretty pictures of trees, windmills and solar panels and assume that their investment in ESG products will help save the planet.

Trending Up for ESG

I hate to say it, but greenwashing in the investing business is rampant.

The twist is that a lot of it is unintentional.

You see, there are very few people within the asset management industry that truly understand the mechanics of what they’re building and selling. Many industry participants might have an above-average (i.e. more than the general population) understanding, but not deep enough to really get the nuances.

Consequently, product features and benefits can be misrepresented and many investors buying these products don’t have a complete understanding of what they’re buying.

Of those who are more knowledgeable about investing, many appear quite skeptical of the real value of ESG products. A recent informal survey shows this:

The goal of this article isn’t to rip anyone a new one (I’ll save that for other articles). Most people – asset managers and investors – have the best intentions. So instead, I’d like to provide a quick summary of major types of ESG investment products.

Values-Based ESG Funds

Most ESG investment funds use a set of screens to filter out sin stocks, like tobacco, energy and gambling companies. Some use a sweeping approach that removes entire sectors. Others look at revenue sources for individual companies to determine exposure. Regardless of the stringency of the filter, the general idea is to eliminate exposure to companies and industries that don’t align with an investor’s values.

These strategies were originally created to service religions endowments and foundations with strict values-based rules. The purpose is to avoid values conflicts and the effects are largely superficial.

Risk-Based ESG Funds

Similar to Values-Based ESG funds, these funds exclude certain companies or industries based on a set of pre-determined factors. The types of companies or sectors that are excluded might closely resemble those of values-based ESG funds. The main difference is the intent of the fund. While values-based funds seek to align with a set of morals, risk-based ESG funds seek to reduce exposure to risk.

While values-based funds seek to align with a set of morals, risk-based ESG funds seek to reduce exposure to risk.

Companies with poor ESG practices may theoretically be exposed to greater regulation, litigation or reputation risk. These potential challenges affect the ongoing profitability and financial position of certain companies, negatively changing their risk-return profiles. A devastating announcement, for example, could push a the stock of one of these companies down 5, 10, 20% or more. Many ESG funds seek to avoid exposure to these risks.

Conceptually, this is something all fund managers have been doing regardless of whether or not their funds are labeled ‘ESG’. Risk management is part of the investing DNA and ESG risks are simply one of many that are evaluated. Given this, drawing particular attention to ESG risks is more-or-less a outward manifestation of what was already taking place, but perhaps to a more explicit degree.

Values-based and Risk-based ESG funds generally avoid exposure but don’t create change.

Values-based and Risk-based ESG funds generally avoid exposure but don’t create change. This is because the market is not heterogeneous. There are investors that care about ESG considerations and others solely focused on profitability. Therefore, there will always be a class of investors willing to invest in companies with profitable business models, regardless of their ESG practices.

With that said, if a large enough cohort of investors avoids an ESG-offending company its cost of capital could rise. This may prompt company executives to alter business practices (if possible) if company stock trades at a persistent discount. However, avoiding prime offenders like oil producers might only create a market where energy companies trade at a discount, but with little fundamental change to the underlying business. After all, an oil producer exists to produce oil. As long as it has access to capital – which has been proven the case with both the energy and tobacco industries – business will go on with little change (or worse, corporate window dressing).

It is important to understand cause and effect. Cigarette smoking has declined significantly over the decades, but not because Altria’s cost of capital has risen. Altria hasn’t changed its primary business model because many investors have avoided tobacco stocks since the 1990s. Rather, regulation, taxation, education and litigation forced dramatic change to both supply and demand, reduced smoking rates in the developed world.

Impact ESG Funds

The vast majority of ESG funds provide some combination of values-based and risk-based filtering. However, what many ESG investors believe they are actually getting (and what many asset management companies believe they are providing) are Impact ESG Funds.

Most ESG fund investors want to make a difference, but most ESG funds don’t make any difference at all.

Contrary to popular belief, investment funds that seek to make change must actually buy shares of ESG offenders.

Contrary to popular belief, investment funds that seek to make change must actually buy shares of ESG offenders. The recent proxy challenge started by activist investor Engine No. 1 is a perfect example of an investment manager actually making change. Via an activist approach, Engine No. 1 was able to secure 3 seats on Exxon’s board. This could only be done because Engine No. 1 owned Exxon shares, made a shareholder proposal and rallied other shareholders around its cause. These directors will help push Exxon to transform its business to address the risks of climate change. Engine No. 1 recently launched an ETF (VOTE) that will continue with these types of challenges.

How to Choose an ESG Fund?

Before you invest in an ESG fund you must first know what you’re trying to achieve. A good starting point is determining whether you want to align with personal values, mitigate specific risks or create positive change.

From there, look at the company that manages the fund. Who are the portfolio managers and what is their history with respect to environmental, social and governance issues?

What is the company’s historical environmental practices, beyond specific product offerings? Do executives fly in private jets, for example? Does the company have other business lines (e.g. investment banking) that services clients with opposing interests and how will the company overcome these conflicts?

Perhaps most importantly, use of ESG funds doesn’t absolve one of personal responsibility, nor does it replace government regulation and policy. To reduce carbon emissions, communities – individuals, businesses, governments – must work together to achieve common goals.

ETFs and Funds Investing

Should Canadian Investors Hedge US Dollar Exposure?

After constructing a well-diversified portfolio of Canadian and US companies – using a combination of individual stocks and ETFs – you look at your portfolio’s currency exposure and wonder: “Should I hedge or not?”

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I believe there are reasons for and against hedging US dollar exposure, many of which investors fail to consider.

Most investors incorrectly base their decision to hedge US dollar exposure on their view of the US dollar. While it makes intuitive sense that if one is bullish on the US dollar they’d want unhedged exposure, I believe this is the wrong way to execute on this view.

Some Canadian investors might have 30, 40%+ of their equity holdings allocated to a diverse basket of US companies. They’ve committed a lot of time to ensure individual exposures aren’t excessive and spread across a range of sectors to reduce the risk of one individual weak holding making a significant impact on portfolio performance.

Yet, after all that careful effort they leave their entire US equity position exposed to a single factor: the US dollar. While there may be some nuances (e.g. some US companies will benefit from a weak US dollar), a decline in the US dollar would negatively affect the entire 30, 40%+ US equity position. This is a massive overexposure to a single risk factor.

By leaving a large portion of a portfolio exposed to a single factor investors are taking on significant risk. Many people fail to recognize this.

Historical Canadian dollar performance

If you were to ask Canadian investors during the mid 2000s about US stocks, most would say they stay far away. Why? Because during that time the Canadian dollar appreciated significantly against the US dollar, wiping out investment returns. At that time, currency risk was at the forefront of their minds because they had just experienced its painful effects. Between 2002 and 2007 (a 5 year period!) the Canadian dollar appreciated roughly 60% against the US dollar.

Note: Many investment practitioners argue that CAD/USD is a wash over the long run. The chart below shows that today’s level is close to where it was almost 30 years ago. What this argument fails to appreciate is that not all investors have a 30 year time horizon. An investor with a 5 year time horizon (note that many investors behave like they have 1 year time horizons) would have either experienced a massive tailwind or a massive headwind due to USD exposure. Not a gamble people should take as they approach real-world liabilities, like retirement. Also, the argument that CAD/USD is a wash over the long run erroneously assumes that exchange rates are mean-reverting and deviations are temporary. This is false.

Nobody knows where the USD/CAD exchange rate will head over the long run. Smart people have great guesses, but nobody truly knows. And it’s quite possible that CAD appreciates considerably again, for one reason or another. My point is the risk still exists and it always will.

By leaving a large portion of a portfolio exposed to a single factor investors are taking on significant risk. Many people fail to recognize this.

As with everything in finance and investing, there are multiple considerations. Nothing is black and white, and currency exposure is one of those things.

USD performance during crises

While overexposure to a single risk factor should be avoided in all portfolios, some exposure to the US dollar – due to its safe-haven status – does provide a portfolio cushion in times of crisis.

The chart below shows the level of CAD/USD during the recent crash. From December 2019 to March 2020, the Canadian dollar depreciated roughly 10% against the US dollar. This means that Canadians holding unhedged US assets would have benefited from a buffer.

Below, I’ve shown the performance of two TSX-listed US equity ETFs during that time period. Both are Vanguard S&P 500 Index ETFs, but VSP is currency hedged while VFV is not. You can see how the unhedged version of the ETF declined about 10% less than the hedged version, due to US dollar exposure. A similar narrative played out during the 2008 financial crisis.

So should I hedge or not?

Personally, when given the simple option I hedge. But overall, I might only be about 50% hedged.

My US exposure is attained using a combination of ETFs and individual stocks. Because it is much more time consuming to create my own hedges (e.g. using FX derivatives) my individual US stock holdings are unhedged. However, most TSX-listed US ETFs offer hedged and unhedged versions. In those cases, I buy the hedged ETF.

ETFs and Funds

Will Canadian Housing Market Collapse?

Some fun with charts:

Over the past year, the average house price in Toronto increased by almost $200,000! For those saving up for a down payment, they are another $200k behind.

Over the past several months, home prices in Toronto have gone vertical.

The IMF recently stated that overheating real estate is the greatest threat to Canada’s economy. The IMF provided their own fair value estimates for a variety of Canadian cities.

Toronto: Fair value is 28% below current prices

Vancouver: Fair value is 13% below current prices

Montreal: Fair value in line with current prices

Hamilton: Fair value is 30% below current prices

The proportion of median household income required to own an average home in Canada is approaching the Q2 1990 peak. Canadian real estate entered a long bear market in the early 1990s.

So when will Canadian real estate crash?

Or at least flatline for a while?

Honestly, who knows. People have been predicting a crash for a decade. Anyone who bought that narrative missed out on massive gains and is now likely priced out of the market.

Should I buy a house in Toronto?

I think most people should look at real estate as a rational purchase of shelter, not as an investment. This means taking a look at what you can truly afford relative to your assets and what you can earn while living in a certain geographic area. Compare that to renting (adjusting for square footage and perhaps some lifestyle benefits – e.g. a back yard) and you should have enough information to make a decision.

Unless you’re an investor, nobody should buy real estate with the hope or expectation that prices will continue to rise. Similarly, it is often foolish to hold off on a purchase hoping prices fall.

Of course, nobody wants to make a massive purchase only to watch prices fall 30% over the next couple years.

I don’t take any of this lightly. I understand that many people might run through the numbers and simply determine they can’t afford to live in Toronto, even if they must.

What’s quickly emerging is a two-tiered socio-economic strata – one with the financial means to afford a home and another that must resort to housing densification, cramming more family members into the same dwelling. The first group includes top decile earners and people with family money. The latter is everyone else.

Suggesting the latter group move to find more affordable accommodation is not the answer. The city needs tradesmen, social workers, waiters, day care workers, and so on. A city of lawyers and doctors doesn’t work (and would be a bore).

This is an urgent problem.

A huge portion of Canada’s economy is directly and indirectly connected to real estate. Real estate is the biggest risk to the Canadian economy and it is gutting the middle class. Either real estate prices collapse and hurl Canada into a massive recession or real estate prices continue to rise, further dividing the haves from have-nots.

The Federal and Provincial governments need to immediately create a task force to deal with this issue. While robust policy requires careful analysis before implementing, there are some obvious options that could quickly be executed. Namely, ban blind bids! People are bidding $100k, $200k+ over the next lowest bids driving prices artificially upward. Some people are even making offers significantly over asking not knowing there are no other bids!

Simply eliminating blind bids would cool the frenzy. Let’s start there.

ETFs and Funds Investing

Does ESG Investing Actually Achieve Anything?

Typical ESG investing (aka socially responsible investing, SRI investing, responsible investing, etc.) is a waste of time. It doesn’t achieve what many hope and believe.

ESG investment funds may be counterproductive and actually worsen the issues they are meant to fight.

Instead, many ESG funds only serve to pacify anxious investors who wish to decorate their portfolios with feel-good products. It’s sad to say because both ESG investment product manufacturers and investors usually have the best intentions. They want to do the right thing. Unfortunately, many fail to recognize their efforts are probably counterproductive and likely worsen the issues they are meant to fight.

As global interest in ESG investing rapidly grows, it is critical that investors understand how many ESG investment funds fall short of their implied objectives. trends.embed.renderExploreWidget(“TIMESERIES”, {“comparisonItem”:[{“keyword”:”esg”,”geo”:””,”time”:”2004-01-01 2021-04-02″}],”category”:0,”property”:””}, {“exploreQuery”:”date=all&q=esg”,”guestPath”:””});

What is an ESG fund?

ESG funds are investment products (like mutual funds or exchange traded funds) that are constructed to feature environmental, social and corporates governance factors into their investment process.

Many ESG investment funds attempt to do this by excluding certain categories of sin stocks: guns, tobacco, porn, and so on. With growing concern about climate change, oil is increasingly at the top of the sin list.

The first problem with oil company exclusion is it’s very limited in scope. Oil companies don’t operate in a vacuum and are highly integrated within all sectors of the economy. They are financed by banks. They supply petroleum to chemicals and plastics manufacturers. Plastics are used in the production of millions of products. If boycotting oil companies, why not also their best customers and financiers?

It’s true that oil companies are at the heart of CO2 emissions and shutting down oil companies would stop the flow of petroleum based products throughout the economy. But excluding oil companies from ESG portfolios fails to shut anything down.

Companies have always had to work with various strata of investors who exclude certain investments based on a variety of characteristics. Value investors shun momentum stocks. Most of the world doesn’t invest in Canadian companies. Tobacco and gun stocks have been excluded from many large portfolios for decades. Yet, tobacco stocks, gun stocks and Canadian stocks have continued to perform as expected. Altria (formerly Phillip Morris) has a stellar long-run track record.

Is ESG investing profitable?

The exclusion of companies or sectors doesn’t affect performance. Research from South Africa’s period of Apartheid has shown that boycotting certain companies, sectors or countries is ineffective at altering share price performance.

Companies simply don’t need 100% of investors to be interested in their stock. There will always be a class of investors who don’t care about what they invest in as long as the returns are good.

In fact, the exclusion of certain companies from ESG portfolios may actually improve return prospects for those excluded companies. Perversely, if 80% of investors shunned Altria, for example, causing its share price to decline Altria’s expected future return would rise, attracting the remaining 20% of investors. A smaller pool of potential investors doesn’t change a company’s business prospects, and thus its intrinsic value. There will always be investors willing to capitalize on this. Moreover, without the burden of ESG-related business expenses, Altria’s intrinsic value may actually rise relative to other ESG-friendly companies.

Does ESG investing make a difference?

As conscientious investors abandon a company, the remaining class of financiers care less-and-less about the company’s practices. All things equal, this leaves the offending company to continue as it pleases, perhaps even creating a disadvantage for the ‘good’ companies that must operate under greater constraints.

Investors looking to force change would do better by adopting methods used by activist investors, like Carl Icahn. Activist investors take large stakes in companies they want to change. Shareholders, as company owners, have a right to board representation. The board hires company executives who then run the company.

To create change, investors must not distance themselves from companies with weak ESG practices. Instead, they must directly engage the companies they wish to change.

Research by the European Corporate Governance Institute shows that shareholder activism can create real change:

We study the nature of and outcomes from coordinated engagements by a prominent international network of long-term shareholders cooperating to influence firms on environmental and social issues. A two-tier engagement strategy, combining lead investors with supporting investors, is effective in successfully achieving the stated engagement goals and is followed by improved target performance. An investor is more likely to lead the collaborative dialogue when the investor’s stake in and exposure to the target firm are higher, and when the target is domestic. Success rates are elevated when lead investors are domestic, and when the investor coalition is capable and influential.

Abstract, “Coordinated Engagements”. January 2021

Given this perspective, ESG scores for investment funds (provided by various rating agencies) can be totally misleading. Based on current methodologies at many ratings agencies, to get a high score a fund must have minimal exposure to offending companies. As shown above, this can have a counterproductive result.

Don’t divest. Engage.

None of this is easy. However, if institutional investors (which represent individual investors) combine efforts and own enough of a company to engage the board they can enact real change. This is not an unusual practice, as investors have banded together many times in the past.

As public concern over climate change grows, there will likely be enough energy to make a real difference. However, it is critical that efforts are directed correctly, away from feel-good ESG products and into activist ESG funds.

ETFs and Funds

World’s First: 2 New Bitcoin ETFs Go Live

Please note that I am not commenting on the merits of bitcoin as an investment. To be honest, I’m on the fence. There are very smart people on either side of the argument. Bitcoin is a highly speculative and risky investment that comes with lots of volatility and a real risk of losing some or all of your investment.

February 18th and 19th. Mark those days in your diary, because that’s when the world’s first bitcoin ETFs were launched.

This has been years in the making, as regulatory hurdles seemed insurmountable. Yet, Purpose Investments and Evolve ETFs (both Canadian firms, by the way) are listing bitcoin ETFs one day apart on the Toronto Stock Exchange (TSX).

Until now, investors could only buy bitcoin through a bitcoin exchange, which is cumbersome, or via a closed end fund. While the buy process is simplified using a closed end fund (because it is listed on a stock exchange), the product structure allows the fund’s share price to drift significantly from the value of its underlying assets – in this case, bitcoin.

The ETF structure should address these issues and the performance of the ETFs should more closely track the performance of the underlying asset.

According to an article on Bloomberg:

“There’s sizable untapped interest for a Bitcoin investment that has the benefits of an ETF,” said Todd Rosenbluth, CFRA Research’s director of ETF research. “Unlike pre-existing products, an ETF is unlikely to trade a significant premium- to-net-asset-value. While most ETFs come to market globally with an educational hurdle to overcome, many investors are familiar with what is inside BTCC.”

The U.S. currently has several active filings for Bitcoin ETFs including ones from VanEck Associates Corp. and Bitwise Asset Management, but the price swings notorious in cryptocurrencies and allegations of industry manipulation remain hurdles to regulator approval.

Source: Bloomberg

The Purpose Investments ETF, which listed on the TSX February 18th, gained immediate attention from investors. Basic product details are as follows:

Product brochure

Product fact sheet


Som Seif, CEO of Purpose Investments discusses his company’s new ETF in the following interview with NASDAQ.

The Evolve ETFs bitcoin fund will be listed on the TSX on February 19th:

Product brochure

Product fact sheet


ETFs and Funds

31 Dividend Payers that Raised in December

In my view, a dividend raise is a signal that management is confident in their business prospects – a larger dividend raise, even more so. The following is a list of large cap companies that raised their dividends in December:

(Note: Best viewed on desktop.)

CompanyAnnouncement DateAmountPrevious AmountIncrease AmountYieldEx-DatePayable Date
Darden Restaurants
Lamb Weston
Franklin Resources
Eli Lilly and
Willis Towers Watson Public
Abbott Laboratories
Bristol-Myers Squibb
Edison International
CenterPoint Energy
Carrier Global
W. P. Carey
Campbell Soup
Fortune Brands Home & Security
Erie Indemnity
Realty Income
The TJX Companies
Mid-America Apartment Communities
Alexandria Real Estate Equities
Raymond James
American Tower
WEC Energy Group
Source: Market Beat. While efforts were made to ensure accuracy, we cannot guarantee data is correct.
ETFs and Funds

5 Actions to Take Before Even Considering Investing

For many, investing sounds like a way to get rich fast. People see insane returns of FAANG stocks and bitcoin and think that’s the ticket to wealth.

For some, it is.

For those who have truly built wealth, there are many things that come before investing.

First of all, most people shouldn’t expect to earn triple-digit – or even double-digit – returns into perpetuity. Depending on how far you go back, the average return for the S&P 500 is roughly 10%. Bond returns, even less. So a well diversified investor holding a balanced portfolio might reasonably expect a 6-8% return over the long run.

For someone with $10,000 to invest, that equates to a $600-800 annual return. Hell, even if that person could accomplish 100% returns he’d only gain $10,000 in year one. Nice, but not enough to become rich unless by some miracle that feat can be repeated numerous times.

Nobody gets rich giving all their money away.

Investing is something you do with accumulated wealth. It’s a way to get your money working for you and to maintain your purchasing power. But before you can do that you must first build wealth through simple, deliberate actions.

Action 1: Spend Less Than You Earn

Seems simple. But many don’t live by this rule and rely on their credit cards to cover regular expenses.

Nobody gets rich giving all their money away. It’s so simple I feel stupid for saying it, but here we are. To accumulate wealth you first need to spend less than you earn.

Action 2: Pay Off Credit Card Debt

If you have a credit card balance you’re likely paying around 20% interest. You’ll never beat that return in the market with any consistency. So do yourself a favor and pay off that credit card debt before investing.

Action 3: Aggressively Save

Simply spending more than you earn isn’t enough. Think about it this way: every dollar you save is a dollar less you have to earn in the future. The more you can save now, the closer you will get to financial independence.

While saving 10% of your paycheck might seem daunting, it’s a standard rule of thumb. However, I suggest saving as aggressively as possible. 10% should be the bare minimum.

Action 4: Don’t Leave Free Money On The Table

Many employers have share purchase or retirement savings matching plans. I’ve known so many people who have lost this free money out of sheer laziness. People walk away from a 20, 30, 50% match – equivalent to a 20, 30, 50% instant return – yet spend their energy trying to invest in the next Tesla.

Moreover, these employee savings plans, once set up, are usually a decision-free way to build wealth since the contributions are taken off your paycheck before you even realize the money even existed.

Action 5: Earn More Money

The average age of Robinhood user is 31, and the average account size is $1000-5000. Such small account sizes suggest these people don’t have alot of wealth.

These young people are wasting their time chasing stocks when they’d get a much higher ROI investing in themselves. At age 31, most people are near the bottom of the corporate ladder. Instead of putting $1000 into Air BnB stock, spend that money on a Python course, Canadian Securities Course or CFA designation.

A little self-improvement at such a young age will pay off multiple times over a lifetime.

ETFs and Funds Investing Wealth

88% of Canadian Equity Funds Underperform

It’s a stock picker’s market, right? Investment manager earn their keep during down markets, right? Actively managed mutual funds can take advantage of market dispersion and volatility to pick outperforming stocks, right?


Yet again – through up markets, down markets, calm markets and volatile markets – Standard and Poors (S&P) proves that the myth of active investment management is pure bullshit.

S&P periodically releases the SPIVA Scorecard, which compares the performance of active mutual funds against their benchmarks. Whether looking at Canada, US or UK, this report has repeatedly shown that active managers underperform.

The SPIVA report is probably the most accurate of all mutual fund evaluations because of what it doesn’t leave out. The SPIVA Scorecard accounts for mutual fund survivorship bias. This adjustment is critical to understanding the true extent of manager underperformance over time.

Here’s how S&P explains this important adjustment:

Many funds might be liquidated or merged during a period of
study. However, for a market participant making a decision at the beginning of the period, these funds are part of the opportunity set. Unlike other commonly available comparison reports, SPIVA Canada Scorecards remove this survivorship bias.

Standard & Poors SPIVA Canada Scorecard

Facts (from the SPIVA Canada Scorecard- ending June 30, 2020):

  • 88% of Canadian equity funds underperformed their benchmarks over the past year, in line with the 90% that did so over the past decade
  • On an asset-weighted basis, Canadian Equity funds returned a dismal 7.9% below the S&P/TSX Composite over the past year.
  • U.S. Equity funds posted the highest returns over the past year, with a 6.7% gain on an equal-weighted basis and 10.8% on an asset-weighted basis. Both of these metrics fell short of the 12.1% gain of the S&P 500 (CAD), with 84% of funds failing to clear this hurdle over the past year.
  • U.S. equities offered the best returns over the past decade, with the S&P 500 (CAD) gaining 16.9% per year, but active funds were unable to keep up: 95% fell short, by an average of 4.1% per year on an equal-weighted basis.
  • 53% of all funds in the eligible universe 10 years ago have since been liquidated or merged.

The performance tables below compare mutual fund categories (e.g. ‘Canadian Equity’) against their benchmarks (e.g. ‘S&P/TSX Composite’). The first table shows equal weighted returns (average fund return) and the second shows asset weighted returns (average fund returns weighted by size of assets in a fund). As you can see, there is significant underperformance across all time periods and categories.

This is not just an issue with the Canadian mutual funds industry. Here are some facts about the performance of mutual funds sold in the US:

Facts (from the SPIVA US Scorecard- ending June 30, 2020):

  • In 11 out of the 18 categories of domestic equity funds, the majority of funds continued to underperform their benchmarks.
  • 67% of domestic equity funds lagged the S&P Composite 1500® during the one-year period ending June 30, 2020.
  • In 13 out of the 14 fixed income categories, the majority of funds failed to keep up with their benchmarks.
  • Fund liquidation numbers across segments regularly reached into the 60% range over a 15-year horizon.

The equal and asset-weighted performance comparisons for US mutual funds are equally bad and just as significant as fund underperformance in Canada.

Why do most mutual funds underperform?

It’s simple.

1) Mutual funds charge a fee that can be as high as 3% in some cases (most are probably closer to 2%). Just to perform in line with the benchmark a fund manager has to outperform by the fee charged. They are starting from behind.

2) Mutual fund managers are trying to outperform against millions of other professional investors, all with the same public information. By the very nature of the market, there will be people who are wrong and people who are right. It is very difficult to be repeatedly right about something impacted by an infinite number of variables. Hence, the chance about being right about a particular portfolio (relative to a benchmark) at any point in time is about 50/50. Those odds are reduced over longer periods of time (the odds of flipping heads once is 50%, the odds of flipping heads twice in a row is 25%).

In that it provides no value added, investment fund management is therefore a commodity. An allocation to diversified portfolio of stocks has value, but the overlay of ‘active investment management’ provides no additional value (actually, it subtracts value as shown above). Investors should not pay for something that isn’t delivered. Therefore, investors should not pay active management fees, which are significantly higher than passive fees. This difference in fees could mean the difference between retiring well or retiring broke.

ETFs and Funds Income Investing Investing

Review: BMO Equal Weight Banks Index ETF (ZEB)

With Q3 earnings for the Canadian banks behind us, you might be considering investing in the banks using BMO Equal Weight Banks Index ETF (ZEB). This ETF exclusively holds an equal weight of each of the big 6 Canadian banks. While the convenience of this one-ticket solution is enticing, I believe using this ETF is a bad financial decision for long-term buy-and-hold investors.

I wouldn’t blame you for wanting to invest in the Canadian banks. I believe the banks have provisioned adequately for significant loan losses and are well prepared for the current economic disaster. Furthermore, Royal Bank, TD, CIBC, Scotia and Bank of Montreal respectively pay a 4.2%, 4.8%, 5.6%, 6.3% and 5.1% dividend yield (as at August 28, 2020). Many investors view these companies as interesting long-term holdings.

While ZEB can simplify the investment into Canadian banks into a single transaction, investing in a highly concentrated ETF like ZEB can be a bad idea. Anyone interested in buying-and-holding the Canadian banks for a long time might be better off simply buying the individual stocks.

Forget BMO Equal Weight Banks Index ETF (ZEB)…Buy the Stocks Instead

For example, let’s say you have $20,000 you want to invest. With an MER of 0.61%, ZEB ETF will cost you $122 per year to own plus any trading commissions. That cost (excluding the trading commission) is repeated each year in perpetuity and will rise as your holdings appreciate in value.

In contrast, you can buy 5 of the banks for a total one-time trading commission of between $0 and $50 (depending on your online broker). Let’s be generous and say you could pay $100 in commissions for the round trip. If you plan to hold your investment for a decade ZEB would cost you at least $1220 while owning the individual stocks would cost a maximum of $100.

While it’s true that ZEB rebalances between its holdings, one could easily replicate this at minimal cost annually using the dividend income spit off from these stocks.

Overall, the value proposition for ZEB is fairly weak for long-term investors. Of course, the story is different for people using ZEB for short term trading or hedging purposes. But I would guess that a significant number of people who hold ZEB don’t realize this.

If you’re a buy-and-hold investor I just saved you $1120. Don’t spend it all in one place.

ETFs and Funds

Canadian Mutual Fund vs ETF Flows

2020 has been a tough year, but the investment funds industry has remained resilient. Net Sales are positive and AUM has grown over last year. The crash in Feb/March will affect fee revenue for the year but overall the industry keeps moving forward. As banks report Q3 earnings, we can see that the wealth segment is holding it together. Today (August 25th) BMO beat street estimates based on wealth and trading activity. We’ll see how RBC, CIBC and TD do, as they report later this week.

In line with the entrenched trend over the past several years, ETF flows and ETF asset growth surpassed those of traditional funds by a wide margin. This trend is driven by price-sensitive investors aggressively switching to lower-fee ETFs.

While the flows into ETFs are more evenly spread across asset classes, flows into mutual funds are clearly overweight to bonds. This is likely because investors/advisors are more inclined to pay higher fees for active management in the fixed income space. The religion of low-cost passive indexing has not yet permeated the bond portion of the portfolio.

Flows into balanced funds – previously the bread and butter of the mutual funds industry (particularly the banks) – remain conspicuously absent. This is detrimental to bank wealth management divisions, which push managed solutions through their retail distribution channels.

As you can see below, dollar flows into ETFs was more than double that into mutual funds. This is a powerful trend that will likely continue.

Mutual Funds:

  • 4.5% year-over-year AUM growth
  • $3.4b net sales in July
  • $11.2b net sales YTD


  • 26.2% year-over-year AUM growth
  • $7.3b net sales in July
  • $29.9b net sales YTD
Source: IFIC