CIBC strikes again.
On December 6th 2007 before we had the opportunity to rip back the lid from our first coffee of the day, CIBC bank stock dropped 5.4% (down 7.0% at one point during that day). CIBC had announced $billions in write-offs related to the subprime mortgage mess. (About $3 billion so far).
Investors are reminded of CIBC’s Enron related write-off in 2005 (see BTO July 2007 and May 2008). On August 3rd 2005 CIBC surprised investors by announcing a $2.4 billion Enron related write-off. CIBC stock dropped 7.5% that day.
These are nasty surprises for those that had picked CIBC as their favorite Canadian bank bet.
How does the average investor participate in the normally strong, stable and profitable Canadian banking sector while avoiding the occasional blowup?
Again, one answer is Exchange Traded Funds (ETFs) and again, CIBC proves the point.
To review, an ETF is simply a low cost, broadly diversified index fund. ETFs mimic an entire market index by holding ALL the securities in the index. The Canadian financial sector ETF, for example, contains all banks and other financial companies. Banks make up nearly 2/3 of this particular ETF. If the investor likes the banks, simply buy them all with this single ETF purchase. Instant diversification and no single bank stock bet. The investor gets the performance of all banks.
The same day that CIBC dropped over 5%, the financial ETF was down only 0.9% because CIBC was only 7% or so of this ETF. The next day, December 7th, CIBC dropped another 3.34% while the financial ETF dropped only 0.04%.
Same thing on August 3rd 2005. The financial ETF dropped by only 1%. By August 10th, CIBC had dropped 12.2% but the financial ETF was down only 3.2%.
To the end of April, the one-year return for CIBC is about -25%. The one year return for the financial ETF is about -7%.
The impact of CIBC was buffered by the diversification inherent in the financial ETF. That’s what ETFs do. They moderate the impact from the worst but still participate with the best. The good offset the bad. Overall performance is therefore smoother. And smoother performance means a portfolio is more predictable. It makes your morning coffee more enjoyable too.
It should be said that CIBC is big, diversified and normally profitable. Its retail operations are fairly stable. The investment banking side of its business is usually the source of return volatility – good and bad. CIBC is an easy target but Bank of Montreal 1 year performance was as bad.
So for again proving the ETF point, thank you CIBC.
Originally published in the Business Thompson Okanagan news, August 2008.
Doug Cronk CFA is Manager, Investments for a Canadian Pension Fund.