The Tarik.ca Canadian ETF Cheat Sheet lists all the Exchange Traded Funds which currently trade on the Toronto Stock Exchange including plain vanilla equity funds, fixed income products and leveraged ETF’s.
Monthly Archive for December, 2007
Recently a Morningstar article as noted that the TSX Composite has beaten 93% of Canadian Equity Funds over the last 5 years. This not at all a new phenomenon, in fact it is an endemic problem which has always faced the mutual fund industry. And in the longer term the failure rate is even higher. This is caused by many factors including excessive trading, high fees, bad market timing, the generation of capital gains taxes and performance chasing.
Part of the solution is to construct a core-satellite with index linked Exchange Traded Funds constituting the core of the portfolio and with stock and individual pics acting as satellite to complement the core. In the coming weeks I will further describe my process of portfolio construction as well as the benifits and the roles Exchange Traded Funds can play in an investor’s investment strategy.
Closed End Funds are basically mutual funds which trade on the open market. However unlike mutual funds, closed end funds are not created or redeemed on a daily basis. On the contrary when a closed end fund is created there is a fixed number of units created at the beginning. Hence as the Supply/Demand for a fund changes, the fund will trade at a discount or at a premium to its net asset value. Funds which trade a unusually large discount their net asset value, sometimes present an opportunity to appreciate quicker since investors will take advantage of discount to buy a dollar’s worth of asset for less than a dollar. Furthermore if a fund trades at an unusually large discount the issuer can file a “Normal course issuer bid” wherein the fund manager buys back the units and profits from the difference between the market price and the net asset value, hence causing the discount on the fund to shrink. Income oriented CEF selling at large discounts can also be attractive to investors since it artificially boosts the yield one might expect in the open market while taking on the same amount of risk.
However not all large discounts are buying opportunities. For example a well managed fund will usually sell at a premium and poorly managed funds will usually sell at discounts. One might see discounts sometimes due to difficulties such as improper NAV calculation or due to the frequency of NAV calculation. The key here is to look for larger than historically usual discount. Hence such a discount should be larger than 15% for it to be notable.
The following two closed end funds trade at unusually large discounts greater than 40% and I believe that they will perform well in the coming months:
1) High Income Preferred Shares Corporation (TSX:HPF.PR.B) is a CEF which holds preferred shares and it currently boosts a dividend yield greater than 15%. While preferred shares were weak in 2007 the fund’s shareholder oversold the fund in an illiquid market which exaggerated the fund’s decline below the NAV. The discount will not last long as yield hungry investor will come along and scoop up the fund and it’s impressive yield. Furthermore the fund manager issued a “Normal course issuer bid” which is in effect in 2008 which will close the discount.
High Income Preferred Shares Corporation (TSX:HPF.PR.B) is a Buy at $7.00
2) CAPVEST Income Corp. (TSX:CSV) is a CEF which invest in infrastructure income trusts currently it has a yield greater than 11%. The new taxation of income trusts has scared investors from income trusts and has created unusually large discount in income trust based CEFs as investors left the sector. With the income trust sector now stable I believe the discount will close as investors get attracted to the yield and as the fund manager issues a normal course issuer bid.
CAPVEST Income Corp. (TSX:CSV) is a Buy at $0.90
You can check the Premium/Discounts on Closed End Funds online at: http://globefunddb.theglobeandmail.com
To many individuals preferred shares are an obscure investment which they know little about. However with a little research you will discover that they are a great alternative to a fixed income mutual fund. Preferred share are shares who are usually issued at $25 and pay a fixed dividend per share per year. Preferred shareholders have preference over common shareholders in dividend payments, as well preferred share holders are paid out first if a company goes bankrupt before the common shareholders. This results in preferred shares being a very safe investment like bonds. Furthermore like bonds preferred shares mature and are redeemed like bonds at their issue price of $25. In the past few months Canadian bank stocks have fallen with the sub prime issues in the the US spilling to Canada. These events has misguided Canadian retail investors to sell preferred shares. In combination with the light volume on preferred shares many issues fell dramatically causing many of them to sell at steep discounts to their redemption price.
These are my current picks for 2008:
Note: To calculate yield to maturity you can use the following online calculator http://www.moneychimp.com/calculator/bond_yield_calculator.htm
Further more not all preferred shares with a high yield are good investments. Preferred shares from chartered banks have virtually no risk, however when buying preferred shares of other companies analysis of their credit rating and financial statements is required.
1) George Weston Limited (Which is the parent company of Loblaws) Series E (TSX:WN.PR.E) is now a Buy at $15.25 per share is currently boosting a yield-to-maturity of 13.785%
2) Laurentian Bank of Canada Series 10 (TSX:LB.PR.E) is now a Buy at $20.00 per share is currently boosting a yield-to-maturity of 10.608%
3) Canadian Imperial Bank Of Commerce Series 32 (TSX:CM.PR.J) is now a Buy at $18.50 per share is currently boosting a yield-to-maturity of 9.807%
4) National Bank of Canada Series 16 (TSX:NA.PR.L) is now a Buy at $20.70 per share is currently boosting a yield-to-maturity of 8.644%
Another important feature of preferred shares is the fact that they pay out dividend and not interest income. So for an individual in the highest tax bracket you multiply the the current yield-to-maturity buy 1.3x to get the interest-equivalent-yield-to-maturity of 17.92% for WN.PR.E.
Note: The preferred shares mentioned above are perpetuals, meaning that redemption is not guaranteed. Over the last 30 years we’ve been in a declining rate environment, those decreasing yields made made the redemption of preferred shares quite probable since the firm would be able to recall them and issue new shares with lower yields. However in a rising rate environment we will most likely not see the same phenomenon occurring (especially when we consider when we are experiencing historically very low interest rates). This leads to the risk that the preferred shares will never be redeemed which is a large risk. All calculations assume shares are redeemed at original par of $25, at the beginning of the furthest call date possible.
It is no surprise that Restaurant Trusts haven’t been on many investor’s radar screen with the industry boosting a minuscule market cap of 1 Billion Dollars (or 997 million dollars to be exact), they are minuscule and illiquid compared to most companies in the income trust index and are easily overlooked by most investors. However they boost a great investment opportunity with many of the restaurant trust trading near book value. Most restaurant trusts have growing same store sales allowing them to increase their distributions in a period where most income trusts are cutting their distributions. On top of the great value they present all these trust pay distributions above the average yield of S&P/TSX Income Trust Index even though they have a more secure and predictable business model than other trusts.
1) SIR Royalty Income Fund (TSX:SRV.UN)———————————14.6% Yield
2) Second Cup Royalty Fund (TSX:SCU.UN) ——————————–11.5% Yield
3) Prime Restaurants Royalty Income Fund (TSX:EAT.UN)—————14.7% Yield
4) A&W Revenue Royalties Income Fund (TSX:AW.UN) ——————9.4% Yield
5) Pizza Pizza Royalty Income Fund (TSX:PZA.UN) ————————9.2% Yield
6) Boston Pizza Royalties Income Fund (TSX:BPF.UN)——————– 9.8% Yield
7) PDM Royalties Income Fund (TSX:PDM.UN)—————————- 14.5% Yield
8 ) Keg Royalties Income Fund (TSX:KEG.UN)—————————— 9.7% Yield
9 ) Priszm Income Fund (TSX:QSR.UN)————————————– 21.8% Yield
Out of all the restaurant trusts Priszm Income Fund (Which owns Pizza hut, Taco Bell and KFC restaurants) at $ 5.45 per unit presents a Buy and the best value out of all the restaurant trusts. In 2007 units fell 54% on when distributions were cut temporarily to raise cash and as they announced restructuring plans. Now that distributions will be restored in 2008 the yield will be equivalent to 21.8%. And now that units are trading a book value there is little downside risk and plenty of upside potential. Furthermore the price of the units will most likely be bid up by yield investors, until the yield declines to about 15% since they now present the highest yield out of all the other trusts.
As the subprime debacle has unfolded many of these bonds have lost most of their value with hedge funds like the Goldman Sach global alpha fund loosing over 60% at one point. The question is currently have these bonds been oversold. For most investors this is a non issue since retail invstors cannot access these securitized mortgages anyways. But thats not completely true.
On the TSX you can buy “Global Diversified Investment Grade Income Trust II” (TSX:GII.UN) which is a closed-end-fund (which is a market traded mutual fund) containing a basket of subprime mortgages. Deutschebank recently rated the net asset value of the fund at $0.80 per unit. A few months ago the fund was trading over $8.00 resulting in a greater than 90% loss. Now that the fund is trading below its new net asset value, and now that the Canadian banks are working to get ABCP deal worked out the fund can potentially rise from its current oversold condition.
“Global Diversified Investment Grade Income Trust II” (TSX:GII.UN) is a Speculative Buy at the current price of $0.70 per unit
As I have been researching fixed income investments over the last few months I have come to the conclusion that, “Fixed Income Mutual Funds are the Scam of the Century”. My research has confirmed my assumptions that every single Canadian fixed income fund has under preformed the Scotia Bank Universe Bond Index over the last 10 years. The simple reason for this problem are the exorbitant MER “Management Expence Ratio” which fund companies charge investors. The MER on Canadian fixed income mutual funds ranges everywhere between 1% to 2%. In a world of of low yield which currently preside, where the Canadian 10 year bond is currently yielding 4.017% an investor is loosing 25 to 50 percent of their profit to management fees while the rest of the profits are lost to inflation and taxation. Furthermore fixed income managers add little value since most investments constitutes government bonds which are risk less and do not require any risk analysis. “If an investor wants exposure to fixed income the investor should manage it individually“.
The Following are some steps an individual can take:
1) One option is to simply take out a bank CD and renew it once it matures. While the yield on CD may be slightly lower than current interest rates it is still better alternative than a fixed income mutual fund. With yields at chartered banks currently above 4.5 % it beats any fixed income fund.
2) The second option is to buy a Canadian Fixed income ETF through the Canadian iShares ETFs. These Exchange Traded Fund will track the fixed income indices, while boasting reasonable MERs between 0.30% to 0.40% making them a much better alternative than buying a fixed income mutual fund while achieving the diversification. Furthermore ETFs are tax efficient and generally more efficiently managed than mutual funds. The following are the current Canadian Fixed Income ETF’s.
a. CDN Bond Index Fund (TSX:XBB)
b. CDN Corporate Bond Index Fund (TSX:XCB)
c. CDN Government Bond Index Fund (TSX:XGB)
d. CDN Long Bond Index Fund (TSX:XLB)
e. CDN Real Return Bond Index Fund (TSX:XRB)
f. CDN Short Bond Index Fund (TSX:XSB)
3) The third alternative to a fixed income mutual fund is to buy preferred shares which pay a fixed dividend per share per year. While you can buy a preferred share ETF, which is the Claymore S&P/TSX CDN Preferred Share (TSX:CPD), I would rather pick individual preferred shares. In next week’s post i will further describe the benefits of preferred shares and reveal my preferred share picks for 2008.
4) The fourth option is to buy a TSX listed capital trust from a major Canadian financial firm such as BNS Capital Trust (TSX:SBA), Manulife Financial Capital Trust (TSX:MFT), RBC Capital Trust (TSX:RYT), TD Capital Trust (TSX:TDD). When you buy a unit of this trust your lending money to these major banks/insurance companies. In return your will get around a 7% yield instead of the 4% you get from a GIC from the bank as a retail consumer. These capital trust are similar to bonds as they pay regular interest income and they will mature at a future date.
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