Purchasing Canadian ETF’s on the TSX

Indexing_Image

When it comes to purchasing ETF’s, for a detailed explanation of what is an ETF (ETF definition), you may question how you can build a portfolio that meets your needs. There are many books that talk about how to purchase ETF’s and/or how to build a portfolio. Unfortunately, many are based on the US stock market. Therefore, I decided to make an article for Canadians based on the TSX, Toronto Stock Exchange.

Table of Contents

What will I cover

Understanding Risk

ETF Providers on the TSX

Tools of the Trade

Investing Strategies

Free ETF Trading Courses

Creating a Portfolio

Tips from an Average Investor

Types of ETF’s

Scenario #1 – Money Market Fund

Scenario #2 – Rags to Riches

Scenario #3 – Couch potato investor

Scenario #4 – Custom Investment Style

Know what you are buying

TSX Indexes and what they mean

Final Thoughts

What will I cover

I will provide links to various websites that I found useful. Furthermore, I will show you how to read and use the data provided to allow you to make more informed investment decisions.

All the links I provide point to free to use and/or access online material.  I currently have not found a need to enroll in a paid web subscription.  In other words, I am frugal.  Although, I am pretty sure that paying for any premium service will provide the subscriber with an advantage over free users. In any case, going back to free will most likely be hard to do once you see all the benefits that are included with a paid subscription.  Nevertheless, you will have to decide if you are willing to pay extra for the additional benefits of being a paying subscriber.

When I first started reading about securities, I had a lot of questions that were left unanswered. All of the answers I got from the Internet. Therefore, I will provide links and/or answers that I have received.

Understanding Risk

When it comes to risk, you need to determine how much are you willing to lose or gain. The basic rule is that if a security can go up 50%, it can also go down 50%. Therefore, that is the first thing you should ask yourself.

Low Risk – Securities can gain or lose about 30%.

The securities that generally fall under the low risk category are short term bonds, large sized companies, and developed nations.

Medium Risk – Securities can gain or lose about 31%-50%

The securities that fall under the medium risk category are medium term bonds and medium sized companies.

High Risk – Securities can gain or lose over 51%

The securities that fall under the high risk category are long-term bonds, small-sized companies, and emerging markets.

The percentages above are what I think fits under each category. Therefore, you may consider 30% or higher a high risk security.

A rule of thumb that is simple to follow is that the larger the corporation by market capitalization, the less risky the security is. Therefore, Telus, McDonalds, and Starbucks are less risky than a corporation that only has a few small stores.

In the case of bonds, Canadian Government bonds are considered the safest, but they also offer the lowest yields AKA returns. Therefore, the more riskier the bond, the higher the yield.

ETF Providers on the TSX

The following link will lead to the website that will give a complete list of all ETF providers on the TSX. This link also has other ETF related tools that you may find useful.

apps.tmxmoney.com/etp/discovery/providers

Tools of the Trade

When it comes to finding the best time to buy or sell a security, there are many methods available. These methods fall into two categories. Fundamental Analysis, the study of the corporation’s financial statements, and Technical Analysis, the study of the corporation’s historical charts and determining trends and/or patterns.

For the purpose of evaluating ETF’s, Technical Analysis is what you will need to understand.

TMXMoney at http://www.tmxmoney.com/ and Yahoo Finance at http://ca.finance.yahoo.com/ provide the technical analysis tools used to determine if a stock is a buy or a sell.

TMXMoney

To use the tools available to do technical analysis, you have to create an account. Under the header there will be a tab labeled My Portfolio & Alerts. Clicking that tab should take you to the login or register page. From there, you can begin using your account to add stock symbols, analyze ETF’s and do various other things.


Yahoo Finance

Fortunately, you do not have to create an account. Yahoo Finance only requires you to enter the stock symbol to look up. From there, you can click on Basic Tech. Analysis under the Chart heading on the left hand side to access the many technical analysis tools.

Morningstar provides a Canadian ETF screener tool to filter Canadian ETF’s based on your criteria. It can be found at http://www2.morningstar.ca/tools/screener/ca/ETFscreener_b.aspx

TMXMoney, which is owned by the TSX, also has an ETF screener. Furthermore, TMXMoney has a list of ETF’s and ETF providers on its stock exchange. Therefore, finding Canadian ETF’s that track an index can be found at http://www.tmxmoney.com/en/sector_profiles/exchange_traded_funds/screener.html

Investing Strategies

If there was a method that guarantees that you will always make money playing the stock market, I will be glad to hear of it. Unfortunately, if that was true, there would not be people still trying to beat the markets. Furthermore, there would not be countless ETF’s with various objectives.

Therefore, I will list some strategies used by various stock traders when buying ETF’s.

Seasonal rotationhttp://www.investopedia.com/articles/trading/05/020305.asp

Bollinger Bandshttp://www.investopedia.com/articles/trading/05/022205.asp

Exponential Moving Average (EMA)http://www.investopedia.com/university/movingaverage/movingaverages1.asp

Free ETF Trading Courses

Investopedia.com – ETF’s are a basket of securities. Therefore, fundamental analysis is not very useful in evaluating the ETF. Technical analysis is currently what I use to determine the best time to buy or sell an ETF. The course for technical analysis can be found at http://www.investopedia.com/university/technical/default.asp.

One or more strategies can be used to evaluate an ETF. I currently use the 200 day EMA to evaluate ETF’s.

Creating a Portfolio

When you talk to a financial advisor, he/she will recommend securities based on how much you will need when you retire, how much risk you can tolerate, and other criteria. Therefore, creating a portfolio is dependent on how you answer his/her questions. Unfortunately, with the market being volatile, there is no guarantees that the portfolio that the financial adviser built for you will get the expected returns.

I buy and sell ETF’s on my own. I know my limit, and I diversify into different markets. I have my own version of what is diversified. Furthermore, disasters around the world may make diversifying a bad idea. Therefore, I must keep up with the news and ensure that I fully understand that not all news is bad for the markets. The prices of securities can fluctuate with the confidence of the investors. Therefore, I watch the news and the markets carefully.

You, as an investor, will realize that not all securities move in the same direction. Some securities will move up while others will go down. This is the reason why diversifying is a must. You may not catch all the upswings but being diversified ensures that you will catch some. Furthermore, if you invest 100% in one security and it loses 50%, you can be certain that another security may have increased 50% or more.

Tips from an Average Investor

ETF’s are best purchased in lots

ETF’s unlike mutual funds cannot be purchased in fractions of a share. Therefore, you will have to purchase the ETF’s on the open market in increments of 1. Although, 1 is considered an odd lot and may be hard to find a seller.  Therefore, ETF’s should be purchased in multiples of 100 shares.

There is no such thing as a sure thing

If you are an insider or can get insider information, then the above can be false.

I have watched the news and heard analysts say that the USA has an 80% chance of entering a recession.  The TSX drops 2 percentage points.  After a week, the USA jobs report comes out and the USA has added jobs. The analysts have downgraded their chance of the USA entering a recession to 20%.  The TSX increases 3%.  Then China’s exports decreased and so does the TSX. The analysts now report that the USA has a 60% chance of entering a recession.  The TSX bounces from positive to negative to end slightly higher.

The message I am trying to convey is that analysts are there to give their opinion based on the information provided to them. You will have to listen to what they say and monitor the situation. Different analysts may provide bits of information that can help you minimize the risk of suffering huge losses.

Diversify based on how much you know

I will purchase 100% stocks (equities) if I am confident about the stock market. I purchase 50% Canada, 25% USA and 25% rest of developed world. If I am uneasy about a country or the world in general, I will either invest in short term bonds or hold cash.

In my opinion, to properly diversify, you should purchase 50/50. 50% stocks and 50% bonds. Of that, invest an equal amount in the three regions I have invested above. It may be boring. You may not make or lose much, but crying over losing your fortune is no laughing matter.

An article that talks about diversifying your portfolio can be read at http://www.investopedia.com/articles/basics/05/diversification.asp and the popular portfolio types at http://www.investopedia.com/articles/basics/11/5-popular-portfolio-types.asp

Bonds prices rise and fall inverse to Canada’s Prime Rate

Short term Canadian bonds are less affected by Canada’s Prime Rate which is why I use them as a savings account. When you start buying Canadian bonds with 25 years to maturity, a small rise or fall in Canada’s Prime Rate can have a huge impact on the bond price. For example, if Canada’s prime rate rises from 1% to 1.25% and the price of both a short-term bond and a long-term bond is $20 on the open markets before the rise, the short-term bond may drop to $19.75 while the long-term bond may drop to $19.00 with the interest rate hike.

The amount of Interest that a Canadian bond pays is determined by several factors:

  • Less risky = less interest AKA government bonds
  • More risky = more interest AKA corporate bonds
  • Short term = less interest
  • Long term = more interest

For a look at the grades used to determine a bonds credit rating, http://www.investopedia.com/terms/b/bondrating.asp

Lending money to Telus, Rogers, Bell, or Shaw Cable is fairly safe. They pay more interest than the government and the risk of these companies defaulting should not be a concern.

An article that talks about bonds can be read at http://www.investopedia.com/university/bonds/

Asset backed securities

If you do not remember the Asset Backed Commercial Paper crisis in Canada or want to read up on it, you can find the article at http://www.investopedia.com/articles/bonds/08/commercial-paper.asp.

Based on the problems that can arise with asset backed securities, you will have to determine if it is risky or not. Backing a bond with assets to decrease the interest paid to the bondholder is a possible minefield.

Finding historical returns for new ETF’s

Many ETF’s track an index. Therefore, if an ETF does not have much of a history to look at, look for the index that it tracks. The underlying index may have a long history. Unfortunately, historical returns do not always equal future returns.

The TSX Index’s that various ETF’s track can be found at http://web.tmxmoney.com/indices.php?locale=EN

News is just news

Unless you are a day trader, the news can move the markets and trying to catch the best times to buy or sell is nearly impossible. Furthermore, investors can be jittery. Therefore, if you hear good or bad news, try looking online to see what the analysts are saying. Http://cnbc.com, American stock market news, and http://bnn.ca, Canadian stock market news, are good stock market news resources. For example, when the Eurozone mentioned on the news that it has a solution to their debt crisis, the markets turned positive. Analysts examined the Eurozone solution, and they could not understand why the investors got excited. The Analysts determined that the Eurozone solution is just talk. The very next day the markets turned negative.

The markets can go up and down at alarming rates in a day or less just on glimmers of hope or despair. Therefore, keep a level head and do not fall into the emotional trap.

Stock Volume

I have seen ETF’s that have zero volume at the end of each trading day. Some ETF’s even have zero volume at the end of each week. Although this may seem troubling, some ETF’s are thinly traded. Therefore, it is a good idea to see why the volume is so low.

In the case of iShares XVX, the bid price, 15.98, and the asking price, 18.95, are far apart. Therefore, the reason why zero shares have exchanged hands is because both the buyer(s) and the seller(s) refuse to agree on a common price point, and in this case, it does not look like any shares will trade hands tomorrow unless either the buyer and/or the seller agree on a set price. With the bid/ask spread being so wide, one can assume that very few buyers are interested in purchasing this particular ETF unless the seller reduces his/her price. Hence, the wide bid/ask spread.

In theory, you should not have any problems buying or selling a security. After all, reduce the price of the security to 99% off, and I am sure someone will take it off your hands.

It is best to stick with securities that have a high daily trading volume.  When the time comes to sell, you should have no problems getting a price close to the last traded price.

If you are a risk-taker, you can purchase a low volume stock and wait until the traders notice your stock.  Usually positive news about a particular stock or industry brings interest into your stock which can be sold easily for a higher price.

The Stock market is a game

Since ETFs are traded like stocks, you need to understand trading.  If there are 0 bidders for your stock, you will not be able to sell.  You will have to wait or place a GTC, Good til Cancel, order with a price.  It may take months to find a buyer since it is most likely an ETF with very few interested buyers.

What I have learned is that the goal of many investors is to make lots of money. Therefore, it is apparent that there are investors both big and small that like to play games. The games they play can be read at http://www.investopedia.com/articles/trading/06/Level2Quotes.asp

The other stock market terms you must understand are the short squeeze, long squeeze, pump and dump and other possibly new methods that I do not know about yet.  These methods can manipulate the market especially if the entity doing the buying or the selling has a large amount of capital to invest.  Remember that the market can be inefficient and you will have to determine what securities are considered a good deal.

Types of ETF’s

Instead of explaining the different types of ETF’s, an article that talks about the difference between an ETF and a mutual fund can be read at http://www.investopedia.com/articles/exchangetradedfunds/08/etf-mutual-fund-difference.asp

When I look at what ETF’s are being traded on the TSX, I break them down into categories.

Money Market ETF’s – These usually contain short term bonds that are pretty much identical to a savings account at a bank, but short term bonds carry minimal risk vs almost none at at bank. Money Market Funds bond prices will go up and down, but the movements are usually very small. Furthermore, the interest paid to the bond holder is usually better than a bank.

Government bonds that mature in 5 years or less are the safest. Corporate bonds that mature in 5 years or less are riskier than government bonds. Both of these are usually found in money market funds.

Index tracking ETF’s – These will track a specific index and will have varying numbers of companies within them. For a complete list of indexes that can be tracked on the TSX, you can visit http://www.tmxmoney.com/HttpController?GetPage=EquityIndices&SelectedIndex=0000&IndexID=0000&Exchange=T&SelectedTab=QuoteResults&Language=en

Actively managed ETF’s – Although they usually have a higher MER than passively managed ETF’s, I do purchase them if I think they have a good strategy.

Adviser series ETF’s – As of Nov 2011, I have noticed that various ETF’s have popped up that charge an adviser fee.  If you purchase ETF’s through an adviser, he/she may purchase these higher fee ETF’s that pay the adviser a commission for his/her services.

Leveraged – Uncomfortable with the increased volatility, I do not buy leveraged ETF’s. It sounds great when the ETF goes 2x or 3x as high as the underlying index, but when it goes down 2x or 3x as much, that is not so great.

Inverse – This is shorting, betting the stock price will go down, the company stocks. I have a bias against shorting stocks, therefore, I will most likely never purchase ETF’s that short company stocks.

Bull and Bear – I do not understand how this works, so I just avoid them. Although, I believe this is identical to leveraged and inverse funds.

NOTE:  I highly recommend reading up on leveraged, inverse, bull and bear ETFs since they are not well understood by many beginner investors.

For the sample scenarios, I will not use leveraged, inverse, bull and bear ETF’s in all except one scenario.  The ETF screener tool used for the following scenarios are available at http://www2.morningstar.ca/tools/screener/ca/ETFscreener_b.aspx

Scenario #1 – Money Market Fund

You have decided that you want to put your money in a security that will act as your savings account. You are not comfortable with the huge swings up and down. Therefore, you want to find securities that will pay some interest and have a history of keeping price fluctuations to a minimum.

For this situation, you will choose the lowest Standard Deviation 3 Yr. We will also choose the Fixed Income Style Box that is for high quality, short bonds.

Short Term Medium Term Long Term
Safe

X

Average
Risky

The selection of bonds is very limited. Unfortunately, with the uncertainty of the markets in 2011, Canada’s bonds are currently very safe and least volatile. Increasing the Standard Deviation 3 Yr. value should provide more results, but increasing the Standard Deviation 3 Yr. value will increase the risk.

Scenario #2 – Rags to Riches

You have decided to take the chance of risking everything you own to win big. You are an avid gambler that could care less about losing everything. You either win big or go homeless.

In this particular situation, bonds are not included since bonds are fixed income securities. Bonds do not increase in price when the company performs well or decrease in price when the company performs badly.  Therefore, only equities are listed.

Leveraged funds are listed since leveraged funds magnify the gains or losses.

In general, large cap companies grow less than small cap companies, but I included them in the results.

Scenario #3 – Couch potato investor

You want an ETF that will encompass all markets. Furthermore, you do not want to have to deal with rebalancing your portfolio. You want an invest it and forget it ETF.

iShares Complete ETFs

Claymore Complete ETFs

In this particular case, there is something called funds of funds. The fee to manage these funds are higher, but for the lazy investor, it can be a viable option.

Scenario #4 – Custom Investment Style

iShares has a portfolio builder that will pick various ETF’s from their selection based on how you answer some simple questions. The portfolio builder can be seen at http://ca.ishares.com/ishares_etfs/model_portfolios/index.htm.

As for me, my strategy will change from time to time.  Although, for lazy investors, I will like to give my recommendation for building a portfolio.

Bonds – 10% should be invested in high-grade short-term corporate bonds. These often offer better returns than government bonds and in my opinion, the risk is manageable. iShares XSB is an example of a short-term bond that I will buy. Although, it contains all Canadian government and corporate bonds. I have yet to find a bond that purchases all corporate bonds from both developed and emerging markets.

NOTE: With the current prime rate in Canada at record lows, 0.5%, buying anything longer than short-term bonds is not a good idea. The price of the various bonds decrease as the prime interest rate rises, but the longer the term of the bond, the more the price will drop. This is a general rule, but investor confidence also seems to have an affect on bond prices also.

Equities – 90% should be invested in non-leveraged stocks. The reason I say non-leveraged is that leveraged stocks use complicated financial instruments to increase the magnitude of the increase or decrease of the stock price. A rise of 2 times the underlying index is great, but a 2 times loss of the underlying index is concerning. Therefore, I stick to the plain and simple stocks.

I recommend the following when purchasing equities (stocks):

  • 30% S&P/TSX Composite Index (Canadian index) (Safe)
  • 30% S&P 500 Index (US index) (Safe)
  • 30% MSCI EAFE Index (Rest of developed world index) (Risky, but maybe safe if EU solves their problems)
  • 10% MSCI Emerging Markets Index (Countries that are very volatile) (Risky)

This is probably considered an aggressive portfolio. Although, I think this will work for many younger Canadian investors. For older investors that are retired or near retiring, more short-term bonds and less equities is probably a better choice.

Know what you are buying

When it comes to purchasing ETF’s, there is a lot of data available from different sources. Therefore, I will go into detail on how to decipher the jargon.

I will not go over every detail since some of the information should be self explanatory.

For the ETF XIC from iShares, the following information is provided at http://morningstar.ca shown above:

  • Last Price – The last listed price before the TSX closed for the day.
  • Day Change – How much the price went up or down from the price when the TSX opened.
  • After Hours – When the TSX is closed, trading continues elsewhere, and the final price is listed on the close of the after hours trading session.
  • NAV – The assessed value of the underlying securities.
  • Open Price – The price of the security when the market opened.
  • Day Range – The lowest and highest price of this particular security during this trading session.
  • 52-Week Range – The lowest and highest price of this particular security during the last 52-weeks.
  • Yield TTM – This is the amount paid out to the investor in the form of dividend payments over the past 12 months as a percentage of the current stock price.  Therefore, if the stock cost $10 and the dividends paid out is $1 over the previous 12 months, the Yield TTM will be 10%
  • Total Assets – The total value of all the shares for this particular security if they were all converted to cash at market value.
  • Expenses – What this ETF manager charges per year to manage this ETF. Unfortunately, Morningstar does not have a value for this, therefore, you will have to go to iShares and find the Management Expense Ratio (MER) per year.
  • Prem/Discount – Since this is traded on the TSX, this ETF is affected by supply and demand. Therefore, this security can be above and below the actual value of the underlying securities.
  • Volume – How many shares have changed hands that day.
  • Average Volume – I am unsure, but I am assuming this is the average over a 12-month period.
  • Leverage – Is this using complicated instruments to increase the magnitude of the rise or fall of this stock price.
  • Bid/Ask/Spread – Highest bidding price – Lowest asking price – What is the difference between the bid and ask price.
  • Category – What kind of security is this.
  • Style Map – This will tell you what this stock invests in. In the case of XIC, large companies that can be undervalued or have further growth potential.
Large Companies
Medium Companies
Small Companies
Potentially undervalued companies

← A bit of both →

Companies with further growth potential

Http://iShares.com, shown above, also has XIC on their website. Therefore, I will go over the details that may not be clear to the average investor.

  • Units Outstanding – Since this ETF is traded on the stock market, it has a limited number of shares available. This particular securities has over 66 million shares outstanding.
  • Total Holdings – How many different companies are being held under this ETF. Holdings can be companies, bonds, or other security types, therefore, it is a good idea to look under the Holdings tab to see what exactly is being held and in what percentage.
  • Commencement Date – When this ETF was first introduced to the general public.
  • Related Index Name – What index is this ETF tracking.
  • Fees & Expenses – The important number here is the MER before waivers and absorptions. It is said that iShares is no longer going to absorb the taxes charged. Therefore, this ETF charges a .27%/year management fee.

TSX Indexes and what they mean

People often mention that it is difficult to beat the index.  This does hold true, but I often question.  Which one?

When you look over the TSX, there are several indexes available.  The gold index may have increased by 50% over the year while the TSX Composite dropped 10% over the year.  Therefore, beating a winning index will be nearly impossible.

When you watch and/or listen to the business news, you will hear about the TSX Composite Index going down or up for the day.  Therefore, I will go over the general indexes and what they represent.

An article that talks about the TSX Indexes in general can be read at http://www.tmx.com/en/pdf/RTREDescription.pdf

TSX Composite Index – This is a general benchmark for the Canadian economy as a whole.  Therefore, if this index goes up, Canada is in good shape.  If this index goes down, Canada maybe in trouble.

TSX Venture Composite Index – This is a general benchmark for the Canadian small businesses.  Companies that are too small to to be included in the main TSX Index are listed here.  An indicator of how the small business environment is doing.

Quite often the TSX Composite may go down, but the Venture goes up.  This can be an indicator that small businesses are doing well, but the larger companies are struggling.

Of course, investor confidence plays a role which can push the index higher or lower.  Therefore, small businesses can be doing poorly, but investors can also be shoving their money into the Venture Exchange pushing the index higher from the high demand.

TSX VIX Index – Known as the “fear” index.  It is often referred to as the barometer measuring how confident or fearful the investors are of the Canadian markets.  Therefore, if this is high, investors are scared and may not put there money into riskier stocks.  The TSX VIX can be read at http://exchange.tmx.com/2010/10/15/tmx-group-partners-with-sp-to-create-a-new-%E2%80%9Cfear-index%E2%80%9D/

TSX Capped Indexes – Indexes that are capped will have companies that cannot be more than 25% of that particular index.  I believe this is good since having one company represent 50% of an index can cause problems since that one company can have a huge impact on the volatility of the index it is in.

TSX Global Indexes – Although the name mentions “Global”, it represents all securities listed on the TSX, NYSE, AMEX, or the NASDAQ stock exchanges.  Therefore, some countries may be omitted if they are not listed on any of these exchanges.

Focused Indexes – These indexes will track a specific sector, security type, or other specific section.  While general indexes can usually consist of over 200 companies, focused indexes can consist of 10 companies.  For example, the TSX Composite Index contains 258 companies while the TSX Consumer Staples Index contains 12 companies.

Final Thoughts

When it comes to mutual fund advisors, he/she is unable to buy or sell ETFs on behalf of the client.  Since ETFs are traded like stocks, the financial advisor must have knowledge of how the stock market works.  Furthermore, the price paid for an ETF can change drastically throughout the trading day.

This article will be updated as needed. When I learn something new or find something interesting you will see it here.

The stock market is best viewed as an investment vehicle that will help you reach your financial goals.

Greed and fear are an investors worst enemy and best friend. When you hear that there is a bull market, be careful. Throwing money in assuming that the returns are going to be huge may leave you disappointed.

Therefore, a level head, discipline and patience are required to avoid making costly mistakes. The stock markets are not going anywhere. It will be there waiting for you tomorrow, next month or next year. The various ETFs will go up and down, but rest assured, when you are ready, so will the ETFs.

Any comments, corrections, additions, questions or advice will be greatly appreciated.

Morningstar’s webpage dedicated to Canadian ETFs at http://www2.morningstar.ca/covers/etf_ca.aspx

Leave a Reply