One of the main ideas behind index exchange traded funds, or “ETFs,” is to minimize costs. After all, these funds need no special portfolio-management skills. The manager simply duplicates the index in question and holds these securities until the index itself changes.
And by holding the securities in the index until the index itself changes, the ETF incurs little in the way of trading expenses.
The result is a management expense ratio, or “MER,” that’s often a fraction of a per cent. Take the iShares S&P/TSX 60 Index Fund (TSX─XIU). This ETF has an MER of just 0.18 per cent. The median managed Canadian equity fund, by contrast, has an MER of 2.47 per cent, more than 13 times this ETF’s MER.
The iShares S&P/TSX 60 Index tries to duplicate the performance of the S&P/TSX 60 Index, minus expenses. The index is comprised of 60 of the largest (by market capitalization) and most liquid stocks of the S&P/TSX composite index. Sectors are intended to mirror sector weights of the S&P/TSX composite.
Sector-weighting determines index ETF’s performance
This is the key to the fund’s performance, as these weights have historically leaned toward the financial and resources sectors. So the performance of these sectors has largely determined the fund’s fortunes.
Over the past decade that has worked out relatively well for the iShares S&P/TSX 60 Index ETF. Its compound annual growth rate over this time is 6.9 per cent, a top-quartile performance in the Canadian equity category.
Over the past three- and five-year periods, however, resource stocks have underperformed the larger indices. So the ETF’s respective results of 11.6 and 7.9 per cent for these periods are just third-quartile performances. Over the past year, however, the ETF’s 0.5-per-cent return is a second-quartile performance.
Given the recent poor performance of resource stocks, these securities hold a less significant position in the S&P/TSX 60 than they once did. The sectors of iShares S&P/TSX 60 currently break down as follows: financials, 36.8 per cent; energy, 19.0 per cent, materials, 8.3 per cent; industrials, 7.7 per cent; health care, 7.6 per cent; telecommunications, 6.5 per cent; consumer discretionary, 6.4 per cent; consumer staples, 4.7 per cent; information technology, 2.1 per cent; and utilities, 0.9 per cent.
Because of its heavy weighting of financial and resource stocks, it’s a good idea to include this ETF in a well-diversified portfolio of Canadian ETFs or mutual funds. That way you’ll reduce sector risk. Otherwise this fund’s focus on Canada’s largest companies makes it a conservative fund overall.
The iShares S&P/TSX 60 Index is a buy as a part of a diversified portfolio if you want market returns over the long term and you can tolerate medium investment risk.
The MoneyLetter, MPL Communications Inc.
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