ETFs Offer a Low-fee Way to Buy Stocks

We still think high-quality mutual funds with a long-term focus will beat indexes over long periods. If funds invest as we advise — sticking with well-established companies and spreading their assets out across the five main economic sectors — they will tend to lose a lot less than the market indexes in periods when the indexes fall sharply.

That’s because big market slides are particularly hard on the hottest, most popular stocks of the preceding market rise, and investing as we do leads you to avoid excessive investment in the hot stocks. Index funds, in contrast, do tend to load up on the hottest, most popular stocks as they rise. That’s because, as they rise, these stocks make up a rising proportion of the index.

The most recent example is Potash Corporation of Saskatchewan, which had the highest market cap on the Toronto exchange in June, 2008, on the strength of soaring fertilizer and agriculture prices. The shares have since dropped 70%.

Index funds are a better deal than the majority of funds now available, however. So if you merely want to equal the indexes, and can accept high volatility, here are some of the best deals available in ETFs. We’ve also analysed one we don’t like.

ISHARES CDN LARGECAP 60 INDEX FUND $12.71 (Toronto symbol XIU; buy or sell through a broker) (units split 4-for-1 in August, 2008) is a good low-fee way to buy the top stocks on the TSX. The units hold a basket of stocks that represent the S&P/TSX 60 Index. The index is made up of the 60 largest and most heavily traded stocks on the TSX. Expenses on the units are just 0.17% of assets.

Most of the 60 stocks in the index are good quality companies. However, to meet the requirement that all sectors are represented, the index holds a few firms we wouldn’t include, such as Biovail Corp.

The index’s top holdings are: Royal Bank, 7.5%; EnCana Corporation, 5.8%; TD Bank, 4.8%; Bank of Nova Scotia, 4.7%; Manulife Financial, 4.6%; Barrick Gold, 4.3%; Canadian Natural Resources, 3.6%; Research in Motion, 3.5%; Suncor Energy, 3.5%; Goldcorp, 3.3%; Potash Corporation, 3.2%; Canadian National Railway, 2.8%; BCE Inc., 2.6%; Rogers Communications, 2.5%; and Bank of Montreal, 2.5%.

The shares trade on the TSX, just like stocks. Prices are quoted daily in newspaper stock tables. You’ll have to pay brokerage commissions to buy and sell the units, although you’ll quickly make that back by paying lower management fees.

Like most index funds, the iShares CDN LargeCap 60 units only add or remove shares from the fund when the underlying index changes. This low turnover is more tax efficient for investors. You won’t incur the regular capital gains bills from annual distributions made by most conventional mutual funds.

iShares CDN LargeCap 60 units are a buy.

S&P DEPOSITORY RECEIPTS $87.32 (American Exchange symbol SPY; buy or sell through brokers) are commonly called ‘Spiders’. The fund holds the stocks in the S&P 500 Index. This index is comprised of 500 major U.S. stocks chosen for market size, liquidity, and industry group representation.

The 10 highest weighted stocks on the index are Exxon Mobil, Procter & Gamble, General Electric, AT&T, Johnson & Johnson, Chevron Corp., Microsoft, Wal-Mart Stores, JP Morgan Chase & Co. and Pfizer. Expenses for the fund are just 0.10% of assets.

If you want exposure to the S&P 500 Index, S&P Depository Receipts are a buy.

DIAMONDS TRUST SHARES $86.04 (American Exchange symbol DIA; buy or sell through brokers) hold the 30 stocks that make up the Dow Jones Industrial Average.

Currently, the fund’s top 10 holdings are IBM, Exxon Mobil, Chevron Corp., 3M, Procter & Gamble, McDonald’s Corp., Johnson & Johnson, Wal-Mart Stores, United Technologies and Coca- Cola. Expenses are about 0.18% of assets.

Diamonds Trust Shares are a buy.

NASDAQ-100 TRUST SHARES $28.62 (Nasdaq Exchange symbol QQQQ; buy or sell through brokers) or ‘Qubes’, hold the stocks that represent the Nasdaq 100 Index. This index is made up of the 100 largest and most heavily traded stocks on the Nasdaq exchange. The index reflects firms across major industry groups including computer hardware and software, telecommunications, retail/wholesale trade and biotechnology. It does not contain financial companies. Expenses are about 0.20% of assets.

The top 10 highest-weighted stocks are Apple, Microsoft, Qualcomm, Google, Cisco, Intel, Research in Motion, Gilead Sciences, Oracle and Amgen.

Nasdaq-100 Trust Shares are a buy for aggressive investors only.

ISHARES MCSI CANADA INDEX FUND $15.98 (American Exchange symbol EWC; buy or sell through brokers) is like a market-cap based index fund, but it tinkers with the index fund formula to try and improve performance by using its proprietary Morgan Stanley Capital International Canada Index. The U.S.-based fund also has to work around foreign ownership restrictions. iShares MCSI Canada Index Fund is managed by Barclays Global Investors and has an MER of 0.54%.

We think that if you want to own a Canadian index fund, you should buy the iShares CDN LargeCap 60. You’ll pay about a third of the management fees.

We don’t recommend iShares MCSI Canada Index Fund.