ETFs push competitive bounds

ETF products just got more complex — to make investing simpler. Barclays Global Investors Canada has launched four fund-of-funds portfolios that are intended to go beyond balanced investing.

Heather Pelant, the head of iShares for Barclays Canada, says there are two reasons for the new portfolios. Not only is it difficult for individual investors to get asset allocation right on their own; it’s also difficult for them to get the rebalancing decision right on their own. The funds, she adds, “are more diversified than balanced funds.”

The portfolio builder funds include ETFs based on the Lehman TIPS Bond Fund, the S&P Global Infrastructure Index and the S&P GSCI Commodity Indexed trust. There is high yield and emerging bond exposure, as well as three real estate funds.

The funds come in two types. One, represented by the Alternatives Completion Portfolio Builder Fund, is designed to round out a portfolio of Canadian equities, bonds and large-cap international shares, with a weight of 20% to 25%; the second, the Global Completion Fund, is meant to complement a Canadian-dominated portfolio. The other two holdings, one conservative and one aimed at growth, can serve as the core of a portfolio, or, indeed, the whole portfolio for a small account.

Cary Blake, the head of Barclays’ global index and markets group, says, “In designing these funds, we considered what has typically been ailing many Canadian investors’ portfolios, which is an overweight in domestic equities and a true lack of diversification.” He argues that the portfolios encompass exposure to such return factors as economic growth, interest rates, liquidity premiums and credit quality.

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The typical institutional portfolio has a 60/40 split between equities and bonds, which Barclays Canada CEO Rajiv Silgardo calls a “semantic diversification” since “equities drive 90% of the volatility.” By contrast, Barclays portfolios are “risk-controlled products.”

Blake says the portfolios will be balanced quarterly. They have been optimized as a strategic long-term asset, he says, with correlations and risk tracked over three-year to five-year “windows.”

“This is something that I think is quite new on the Canadian investment landscape,” he says.

The concept of creating a diversified portfolio of ETFs is something that has been gaining traction among certain private investment counsels in Canada for a while now.

One of iShares’ chief rivals in the Canadian ETF space, Claymore, launched a couple of ETF portfolios in June 2007. The two products are the Claymore Balanced Income CorePortfolio ETF, which is a conservative income-focused portfolio, and Claymore Balanced Growth CorePortfolio ETF, which has an allocation to 80% equity indexes. They are actually the cheapest “ETF of ETFs” products in Canada, according to the company’s president, Som Seif. The annual management fee on the CorePortfolios was reduced from 0.70% to 0.25% on November 17.

Seif says it takes time to get the asset mix of an ETF portfolio right. He says Claymore has to make changes to the portfolio asset mix to account for changes in demand. Most notably, the company has pared down the number of underlying ETF options.

“The feedback we received from investors was that they want less variability in how they are investing and how the portfolios are built. We’ve actually tightened up the asset classes dramatically,” he says. “This makes the portfolios a lot easier and a lot cleaner. It makes the investment vehicle simpler to understand and lowers trading costs.”

Seif says it’s not necessary to have a broad base of ETFs overlapping certain asset classes. He also stresses it’s important that ETF portfolios in the Canadian market reflect the needs of Canadian investors, which should mean a higher allocation to Canadian securities.

“All of our portfolios are built with the idea of asset allocation and incorporating different types of assets that matter from a Canadian perspective — not an American perspective,” he says. “For example, the bias towards Canadian bonds is very important. We’ve done a lot of analysis and found when you look at bonds from a passive perspective, unless you’re actively currency hedging, global bonds don’t add a lot of value. All of the bonds are specifically Canadian bonds. We’ve not gone to the global marketplace to look for bonds.”

Seif says investors also want ETF portfolios that have disciplined allocation, meaning they provide constant asset exposure to certain sectors.

“Investors want to know they’re always going to have exposure to Canadian, U.S. and international equities. It’s not going to go down to zero,” he says.

Mark Yamada, president & CEO of PUR Investing, a firm that offers customized ETF portfolio solutions for clients, says the emergence of all-in-one ETF portfolios was inevitable given the rapid expansion of the ETF market.

“There are now 73 ETFs specifically available to the Canadian market. There are 897 available to North American investors, with over 500 pending registration with the SEC, so that means there will likely be over 1,400 by this time next year. That’s an overwhelming number of ETFs — so the big issue now is selection,” he says. “It used to be easy. You picked the S&P 500, you picked a bond one, and you picked a global one, and maybe you were good to go. Now the choice is staggering. I think what Barclays and Claymore are trying to do is make the job easier.”

While simplicity is a good thing, it’s not always the most ideal way to manage an ETF portfolio, Yamada points out. Risk management is vital to appropriate ETF management. While ETF providers are coming from the right direction in providing asset allocation products, ultimately these types of products should reflect the individual needs of the investor, Yamada says.

“We don’t rebalance a fixed asset mix on a quarterly or annual basis. We rebalance to constant volatility, which adds value to a fixed mix,” Yamada says. “We rebalance our portfolios as part of an equation to finding out what the risk [profile] of the client is. We will do a goals-based asset allocation, using the risk tolerance of the client, but also their investment time horizon, cash flow and income requirements. Then we’ll try to match an ETF portfolio to those specific requirements.”

Recognizing that selection, particularly one informed by specific financial advice, is important, PUR is releasing an online screening tool next week that will allow individuals to create a customized portfolio using as many ETFs as they like. The “light” version of the tool will be available free for visitors to the company’s website.

“Investors are now recognizing this is an intelligent way to invest. There has been a bifurcation in the ETF market of what we call embedded strategies, which includes many of the Claymores and fund of funds and active ETFs. There are so many different types of [ETF strategies] now, the problem is how to sort through them and select a portfolio from them,” Yamada says. “I think what you’re seeing from Barclays, Claymore and even us releasing our tool publicly is how to use them. That’s the next step.”

Filed by Mark Noble mark.noble@advisor.rogers.com and Scot Blythe scot.blythe@advisor.rogers.com, Advisor.ca

(11/18/08)