Recent market action indicates why it’s essential to hold Canadian equity index ETFs as part of a larger, well-diversified portfolio. Heavy concentration in just a few industry sectors makes Canadian ETFs vulnerable to what happens in those sectors.
Market action since last summer has served to illustrate that very problem of passive investing in Canadian stocks. Because Canadian indices are concentrated in just a few industry sectors, finance and resource especially, the performance of exchange-traded funds that track them is bound to be quite volatile at times.
Take Vanguard FTSE Canada All Cap Index ETF (TSX─VCN), for example. This ETF attempts to track the performance of the FTSE Canada All Cap Index, a market-capitalization weighted index, similar to the S&P/TSX Composite Index, which tracks the large-, mid- and small-capitalization segments of the Canadian stock market.
In 2014, Vanguard FTSE All Canada gained 9.9 per cent. By itself, this is a healthy gain. But it lags the return of the S&P 500 Index in the U.S. by a fair amount. That index gained more than 14 per cent for the year.
ETF has lagged considerably
Many managed Canadian equity funds have performed much better over the same time. For example, Mawer Canadian Equity Fund posted an 18-per cent return for 2014, while Franklin Bissett Canadian Equity Fund gained 13 per cent.
In one respect at least, Vanguard FTSE All Canada has done quite well. With about 38 per cent of its assets invested in the financials sector, the ETF has benefitted from robust performance in this sector. Indeed, in 2014, financials stocks gained 11.8 per cent.
But with 21 per cent of its assets invested in the energy sector, the ETF was hurt by the underperformance of energy stocks in the second half of 2014. In fact, the S&P/TSX Capped Energy Index lost 16.3 per cent on a total-return basis for the year. Vanguard FTSE All Canada’s performance was also held back by a loss in its third most heavily-weighted sector — materials.
By contrast, Mawer Canadian Equity has benefitted from active management. Its managers have successfully sidestepped much of the carnage in the energy sector by underweighting these stocks, while benefitting from the relatively strong performance in the financials sector.
Given the lack of diversification in the Canadian market, then, you should make sure that your Canadian equity ETFs form part of a larger, well-diversified investment portfolio.
Canadian Mutual Fund Adviser, MPL Communications Inc.
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