In view of our previous recommendation to ETF investors that they buy unhedged ETFs when investing in the U.S., we now recommend such an ETF for investors seeking exposure to the mid-cap segment of the U.S. market.
Late last year, we recommended exchange-traded fund investors choose unhedged ETFs when investing in the U.S. market. With this in mind, we now recommend iSHARES CORE S&P MID-CAP ETF (NYSE-IJH) for smaller-cap investing in the U.S.
In past years, we recommended iSHARES RUSSELL 2000 INDEX FUND (CAD-Hedged) (TSX-XSU) for the same purpose. In the years following the financial crisis of 2008 to 2009, the Canadian dollar was buoyed, in good part, by its “safe-haven” appeal. Canada’s stable banking system caused large capital inflows into the country, causing the dollar to rise above US$1.
This rise undermined Canadian investors’ returns from their U.S equity investments when exchanged back into Canadian dollars. So hedging against a rise in the loonie made some sense.
Capital flows have reversed
About the middle of last year, however, capital inflows began to reverse, partly reflecting renewed optimism about the global financial system. Thus the loonie has recently fallen below US$0.90.
Weakness in the Canadian dollar also reflects a considerable current account deficit, which means that the value of the goods and services the country imports exceeds the value of those it exports. One way for this to correct itself in the months to come, in the absence of any other factor sparking demand for our currency, is for the Canadian dollar to fall further.
In the near term, then, we see no appeal to hedging the Canadian dollar. And for the longer term, fluctuations in currencies tend to cancel each other out over time. Indeed, studies have shown that ETFs that do not hedge add to the benefits of diversification without sacrificing performance over the long term.
Currency hedging makes sense only for investors with a shorter time horizon, those who don’t want to take the risk the Canadian dollar will rise anytime soon.
We, therefore, recommend iShares Core S&P Mid-Cap ETF for longer-term investors who want exposure to the smaller-cap segment of the U.S. equity market. This ETF seeks to track the investment results of the S&P 400 Index, which is generally made up of stocks with a market capitalization between US$1 billion and $4 billion. Stocks are weighted according to the size of their market capitalization.
With over 400 securities, the ETF is well diversified by individual holdings and industry sector. The industry-sector breakdown is as follows: financials, 22.7 per cent; industrials, 16.7 per cent; tech stocks, 16.0 per cent; consumer discretionary, 13.2 per cent; health care, 9.5 per cent; materials, 7.1 per cent; energy, 5.5 per cent; utilities, 4.6 per cent; consumer staples, 4.2 per cent; and telecommunications, 0.4 per cent.
Another benefit of unhedged ETFs is that they don’t have to pay the costs of currency hedging. Hence this ETF’s management expense ratio is just 0.15 per cent, compared with 0.36 per cent for the Russell 2000 Index Fund.
Buy iShares S&P Mid-Cap ETF for unhedged exposure to the mid-cap segment of the U.S. market.
Modern technology has made such things as fund indexing and daily sub-index reporting simple. You’ll notice the abundance of daily statistical information on investing websites and the websites of companies that offer mutual funds and exchange-traded funds.
But we question the value of such things as daily lists of winning and losing funds. You may find these lists interesting. But resist the urge to take action based on a single day’s activity. Chasing the market daily in mutual funds or ETFs is likely to prove costly.
Canadian Mutual Fund Adviser, MPL Communications Inc.
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