– You’re on the right track when you say that a balanced mix of stock and
bond ETFs would be a good place to start building a portfolio as a novice
Most beginning investors test the waters with either a balanced mutual fund
or with ETFs that track large, well-established stock and bond indices.
These include, for example, the S&P/TSX Composite Index for Canadian
stocks, the S&P 500 Composite Index for U.S. stocks, the MSCI EAFE
Index (that is, the Europe, Australasia and Far East Index) for stocks of
developed countries outside North America.
For Canadian bonds, an ETF that tracks a broad index of both government and
corporate issues would be one to include in a balanced portfolio. The
FTSE/TMX Universe Bond Index is the broadest Canadian fixed-income index. A
wide choice of investable global bond indices are also available, from
index-producers such as FTSE Russell, Dow Jones, Standard & Poor’s, and
MSCI (Morgan Stanley Capital International).
A balanced portfolio of ETFs could be apportioned, for example, 60%
equities (divided into, say, 40% Canadian and 60% non-Canada
international), and 40% Canadian bonds. You could accomplish this with the
purchase of only three broad passive-index ETFs.
So-called “smart beta” ETFs are a relatively recent innovation in the ETF
industry. So perhaps a little defining of terms is in order.
A broad, passive, index-tracking ETF goes back to the roots of
exchange-trade funds, which were developed in the last 20 years of the
twentieth century. It is simply a fund that passively tracks the
performance of a large, capitalization-weighted index, such as the
S&P/TSX Composite Index or the S&P 500 Composite Index.
The individual components of these indices are weighted according to the
size of their market capitalization (the price of a company’s stock
multiplied by the number of shares outstanding). Consequently, the larger a
company’s market cap, the greater its influence in the performance of the
For example, tech firm
Apple Inc. (NASDAQ: AAPL)
recently topped US$800 billion in market capitalization, becoming the
world’s most valuable company. It constitutes about 4% weighting in the
S&P 500. In Canada, the S&P/TSX Composite Index, also
capitalization weighted, is dominated by Canada’s big banks and insurance
companies, as well as larger resource companies in the energy sector.
As the ETF market developed and matured, fund companies began offering ETFs
that aimed to deliver performance better than what can be obtained simply
by buying and holding a capitalization-weighted index. These came to be
known as “smart beta” or “factor based” ETFs.
Smart beta funds basically incorporate, or “overlay,” various types of
active strategies on an index in an effort to enhance returns. These
strategies could include fundamental screens (such as various financial
ratios or dividend growth), low volatility metrics (to reduce risk), high
beta (for aggressive growth), commodities, options, and multi-asset
tracking. Because they tend to use more sophisticated strategies, they tend
to be used more by portfolio managers to augment investor portfolios in one
way or another.
Most smart beta ETFs have higher MERs than standard passive index-tracking
ETFs, and have come under criticism as simply a way for ETF issuers to
collect higher fees.
Moreover, smart beta ETFs are still quite new to the market, and while they
have been back-tested with historical data, they do not have a long-term
performance history through a real-world market cycle.
For novice investors building their first portfolio, then, I’d advise
sticking with tried-and-true, index-tracking ETFs. They’ll give you broad
exposure to the market, they have a long history of performance through
various market cycles, they have the lowest MERs, and they are highly
liquid. Leave the smart-beta strategies for professional portfolio
managers, or until you’re more comfortable with sophisticated strategies
yourself. – Robyn
Robyn Thompson, CFP, CIM, FCSI
, is the founder of
Castlemark Wealth Management
, a boutique financial advisory firm specializing in wealth management
for high net worth individuals and families. Contact her directly by
phone at 416-828-7159, or by email at
for a confidential planning consultation.
Notes and Disclaimer
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The foregoing is for general information purposes only and is the opinion
of the writer. Securities mentioned are illustrative only and carry risk of
loss. No guarantee of investment performance is made or implied. It is not
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limitation, investment, financial, legal, accounting or tax advice. Please
contact the author to discuss your particular circumstances.