More choice for frugal investors
Jonathan Chevreau The National Post Thursday, February 5, 2004
Barclays now has real competition in exchange-traded funds: New ETFs give Canadians access to Vanguard funds

American index fund giant Vanguard Group never did formally come to Canada -- but it no longer matters.

Vanguard's possible entry has long been feared by Canada's high-fee mutual fund executives. Fortunately for them, it's next to impossible for Canadians to buy mutual funds or index funds from American companies unless they set up shop in Canada, as did Fidelity and Scudder.

However, it's a snap to buy foreign exchange-traded funds (ETFs), including 14 new Vanguard ETFs unveiled last week. These are virtually clones of Vanguard's index funds, with Management Expense Ratios (MERs) even lower than the rock-bottom fees on its index funds.

Vanguard's Viper exchange-traded class of shares began trading on the American Stock Exchange last Friday, Jan. 30. Viper stands for Vanguard Index Participation Equity Receipts.

These ETFs promise to shake up the investment world on both sides of the border, as the "costs matter" philosophy of Vanguard founder John Bogle continues to go mainstream. MERs on the new Vanguard ETFs range from 0.12% (12 basis points) to 0.28% (28 basis points.)

Compare that to 2.50% or 250 basis points for a typical actively managed mutual fund sold in Canada. Yes, that's at least a 10-fold difference.

"Anything that increases the competition on the MER front is valuable. This will just increase the pressure," says Eric Kirzner, the new John H. Watson chair of value investing at the Rotman Centre for Management.

The Vanguard ETFs give cost-conscious Canadians one more alternative to high-cost mutual funds, apart from the leading ETF presence in Canada: Barclays Global Investors Canada. MERs for BGI's Canadian ETFs (called iUnits) range from 0.17% to 0.55%.

Far from being concerned, Barclays Canada head of public funds Howard Atkinson says "we welcome Vanguard into the market. It will raise awareness about indexing and ETFs."

Atkinson compares the situation to personal computing in 1981, when Apple Computer Inc. famously welcomed giant IBM into its market with full-page advertisements.

Despite its fast growth, the ETF market is only about 2% of the mutual fund market, Atkinson says. He adds Vanguard may find itself disadvantaged by the "first-mover advantage" earlier competitors gained.

"It will be a challenge for them given there is a comparable index product for everything they're coming out with." But Vanguard is also a major brand with retail investors, Atkinson said.

Another bellwether is the entry of the world's largest mutual fund company, Boston's Fidelity Investments, which last October announced an ETF tracking the Nasdaq exchange -- competing head on with the most successful ETF of them all, the Bank of New York's Nasdaq 100 Trust (QQQ/AMEX).

Fidelity's entry may ultimately prove to be the greater threat to the mutual fund industry, Atkinson predicts. If we end up with quasi-actively managed ETFs, Atkinson said, "Fidelity wants to make sure they're there."

Currently, most ETFs are "passively" based on stock indexes, which is why Prof. Kirzner prefers the term ETIFs, or exchange-traded index funds.

ETFs trade like stocks or closed-end funds on major stock exchanges. For Canadians, it makes little difference whether an ETF is traded on U.S. or local stock exchanges. U.S. securities are of course priced in U.S. dollars and Canadians need to consider local tax and foreign content considerations if the investments are registered. But in principle, buying a Vanguard ETF or i Shares (the American version of iUnits) is no different from buying shares of General Motors or Microsoft.

The ETFs which trade on the TSX are tailored for Canadians. Barclays dominates the field with its i60s, plus several Canadian sector funds and foreign funds which don't consume foreign content room in RRSPs.

State Street Canada withdrew its only retail product, the Dow Jones Canada 40s, from the market (a pity too, since its MER was below 10 bps). The other major domestic ETF manufacturer is TD Bank, which offers value and growth versions of the TSE 300. Other Canadian banks sell no-load index mutual funds as well.

The new Vanguard ETFs track the same indexes as its mutual funds, and include large-cap (W/AMEX), value (VTV/AMEX), and growth (VUG/AMEX) versions of various U.S. stock indexes. It also announced several sector ETFs and will later introduce ETFs tracking MSCI Europe, Asia/Pacific and Emerging Markets.

Vanguard first tested the ETF market three years ago with its Extended Market and Total Stock Market VIPERs.

"Barclays now has competition that will ensure ETF MERs stay low. A secondary benefit is the ability to harvest tax losses between the two sets of ETFs," says the Toronto-based indexing advocate known as Bylo Selhi. His Web site at www.bylo.org shows how Canadians can buy U.S. mutual funds.

However, since Sept. 11, 2001, that has become even more difficult to achieve, Selhi said. Before 9/11, a "back door" method involving a U.S. address was sufficient. Now, however, U.S. fund companies require Canadians to prove they reside at such addresses. "Our regulators don't seem to have a problem with us buying index funds as a stock but do have a problem buying them as a mutual fund."

As we said at the outset, it no longer matters. And in the interests of full disclosure, I'm obligated to remind readers that Barclays Canada sponsors a Web site I manage at www.wealthyboomer.com.

 

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