Canadian-focused FundGrade A+® ETF contenders for 2017
By Brian Bridger, CFA, FRM

Rising geopolitical risk continues to rattle markets despite a recent period of remarkably low stock market volatility. At the same time, interest rates are trending up, and the fall season tends to be one of the worst for equities. So it is understandable that some investors might be looking for low-risk alternatives for their equity and fixed-income investments. Let’s take a look at some possibilities among Canadian-focused ETFs that will be in the running for Fundata FundGrade A+ Awards for 2017.

In the equity ETF space, low-volatility strategies can take on many forms. There are numerous ways to measure volatility and even more ways to select, rank, and weight securities in a portfolio. But the objective is always the same: to create a portfolio tilted towards the least risky stocks. Here are two of the best.

Equity contenders

PowerShares S&P/TSX Composite Low Volatility Index ETF (TSX: TLV) was a FundGrade A+ winner in 2016 and is looking to repeat this year. At 5.9%, it has the fifth highest year-to-date (YTD) return in the Canadian Equity category and the eighth highest average annual compounded 5-year rate of return at 10.7%. True to its name, TLV is one of the least volatile funds in the group, sporting a 3-year annualized standard deviation of just 6.2%, compared with the category average of 8.1%.

TLV was launched in April 2012 and replicates the performance of the S&P/TSX Composite Low Volatility Index, which measures the performance of the 50 least volatile equities in the S&P/TSX Composite Index. Stocks in the index are ranked by 1-year volatility, and the lowest 50 are then weighted inversely proportional to their volatility. Current top holdings of TLV include Intact Financial Corp., BCE Inc., and Emera Inc. The fund has an MER of just 0.34%, compared with the category average of 1.81%, and a distribution yield of 3.8%.

BMO Low Volatility Canadian Equity ETF (TSX: ZLB) is another top-performing fund in the Canadian Equity category, and is trying to earn its fourth consecutive FundGrade A+ award.

ZLB is up 5.6% YTD, ranking it sixth-best in the category, and has an average annual compounded 5-year return of 15.2%, second-best in the group. Average 3-year volatility at 7% is low, although it’s slightly higher than TLV’s 6%.

The fund debuted in October 2011, and in contrast to TLV, which tracks an index, ZLB is a rules-based ETF that selects and weights the 40 lowest-beta large-cap Canadian equities. Beta is a measure of sensitivity to movements in the market, so you would expect low-beta stocks to be less affected by volatility in the market. Beta is measured over five years; however, adjustments can be made for stocks with less than five years of history. There are also caps on security and sector exposure to ensure proper diversification. Top holdings include Fairfax Financial Holdings Ltd., Intact Financial Corp., and Waste Connections Inc. ZLB has an MER of 0.39% and a distribution yield of 2.8%.

Fixed-income contenders

It is important to remember that long duration bonds are a riskier investment than short duration bonds, especially in a rising rate environment. Bond prices move in the opposite direction of yields. So as yields rise, bond prices fall, and vice-versa. The degree to which a bond falls (or rises) depends on its duration. The longer the duration, the greater the price change for each percentage point change in yield. All this to say that investors seeking to reduce their risk should look to the short end of the curve. Here are a few ETFs that are A+ Award contenders in the Short Term Canadian Fixed Income space.

iShares Core Canadian Short Term Corporate + Maple Bond Index ETF (TSX: XSH) was launched in September 2011 and tracks the FTSE TMX Canada Universe + Maple Short Term Corporate Bond Index. The index measures the performance of bonds denominated in Canadian dollars with a duration less than 5 years. XSH has a duration of 2.8 years and a distribution yield of 2.9%. It is the top performing fund in the category, with a 5-year average annual compounded return of 2.5%. The fund is on pace to win another A+ award in 2017 after winning every year since 2014. Helping fuel this outperformance is an MER of just 0.12%, third lowest in a category, which averages close to 1%.

Another fund vying to add more hardware to its mantlepiece is Vanguard Canadian Short-Term Corporate Bond Index ETF (TSX: VSC). This 2016 A+ award winner has the second best 3-year average annual compounded rate of return in the group at 2.2%, behind only XSH. The fund tracks the Bloomberg Barclays Global Aggregate Canadian Credit 1-5 Year Float Adjusted Bond Index, which measures the performance of public investment-grade non-government securities issued in Canada with maturities between 1 and 5 years The duration of the fund sits at 3 years, and the distribution yield is 2.8%. VSC was launched in November 2012, and has the lowest MER is the category at just 0.11%.

Brian Bridger, CFA, FRM, is Vice President, Analytics & Data at Fundata Canada Inc and is a member of the Canadian Investment Funds Standards Committee (CIFSC). This article is not intended as personalized investment advice. Securities mentioned are not guaranteed, involve risk of loss, and are subject to commissions.

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