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How to Select ETFs.


ETF Screening Tools in Practice.

How does an Individual Investor sort through and select from the multitude of Exchange Traded Funds (ETFs)?

Use these ETF screening (sorting or selection) tools:

TMX.  Bloomberg.  IndexUniverse.

Use these Criteria:

Use ETFs from established providers.
Get the asset allocation right.
Be mindful of cost(s).

And use the average PIAC Pension asset allocation as a reference portfolio:

ASSET MIX OF PLANS AT DEC 31, 2010 PIAC Allocation ETF options include Simplified allocation
CASH -1.52%
CANADIAN BONDS 26.20% XBB, XSB 30%
REAL RETURN BONDS 4.58%
MORTGAGES 0.69%
FOREIGN BONDS 1.76% BND
CANADIAN EQUITIES 15.99% XIU 20%
U.S. EQUITIES 6.14% VV 10%
EAFE EQUITIES 5.84% VEA 10%
EMERGING MARKETS EQUITIES 3.05% VWO 10%
GLOBAL EQUITIES 12.42%
REAL ESTATE 8.86% XRE, ZRE, VNQ 10%
V.C. / PRIVATE EQUITY 7.24%
INFRASTRUCTURE 4.15% CIF
OTHER ASSETS 2.98% XAL 10%
HEDGE FUNDS 1.56%

What would an Individual Investors’ ETF portfolio look like if it were constructed using the ETF selection tools, with our criteria and the average Pension Plan (PIAC) asset allocation as a reference portfolio?

Select the largest PIAC allocation(s) first.

Bonds.

For a ~30% allocation to the Canadian Bond market, screen for DEX Universe Bond index ETFs.

The TMX ETF screener can help narrow down the bond ETF choices. (Select asset class & region and de-select Leveraged, Inverse, Advisor class and ETNs).

The IndexUniverse ETF screening tool is U.S.-centric and doesn’t include Canada bonds.

The Bloomberg ETF screener is not as useful. (Select Canada and Debt and you are presented with 70 bond ETFs. Narrow it down by selecting MER < 0.50% and you are left with 18. Only 3 have a 5 year+ performance history).

ETFs that meet the criteria include:

iShares.ca, XBB has been around since November 2000, volume is ~79,000 and the MER is 0.30%. Concerned about interest rates moving up? Then look at a short-term bonds. iShares.ca, XSB has a 0.25% MER, volume of ~17,000 and has a start date of November 2000.

BMO’s ZAG is young (Jan 2010). RBC’s bond ETFs are all Corporates. Claymore and the rest are all too specialized or specific.

What about Real Return Bonds, Mortgages and Foreign Fixed income? There will be some who are just itching to add specialty exposure like Corporate, Hi yield, Laddered, Provincials, Emerging Market or Convertible bonds or other bond ETF that makes a bet on price direction. From a ‘get the asset allocation right’ point of view, specialty allocations are … tinkering. For the portfolio’s strategic allocation, keep it simple. (I do, however, like Vanguard’s BND for U.S. Bond market exposure. It’s cheap at 0.11% but the additional currency risk, in addition to interest rate risk, plus buying on a U.S. exchange may be too exotic for some).

Next time?
ETF selection tools to select Canadian Equity ETFs.
Doug Cronk CFA is Manager, Investments for a Canadian Pension Plan

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