A Member of Pat McKeough’s Inner Circle recently asked for his advice on BMO Low Volatility Canadian Equity ETF, a low-beta fund that specializes in large Canadian stocks.
Pat likes that the fund invests from the 100 largest and most liquid securities in Canada. However, he feels the low-beta approach is too limiting and doesn’t give the full picture for good investing results.
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The BMO Low Volatility Canadian Equity ETF (Symbol ZLB on Toronto; www.etfs.bmo.com) provides exposure to a low beta weighted portfolio of Canadian stocks.
The BMO Low Volatility Canadian Equity ETF selects the lowest beta stocks from the 100 largest and most liquid securities in Canada. The underlying portfolio is rebalanced in June and reconstituted in December. The BMO Low Volatility Canadian Equity ETF has an MER of 0.39%. It currently yields 2.9%.
The BMO Low Volatility Canadian Equity ETF’s current top holdings are Waste Connections, Hydro One, Empire Company, Fortis, Emera, Agnico Eagle Mines, Barrick Gold, Loblaw and Metro.
The BMO Low Volatility Canadian Equity ETF relies on beta scoring, a commonly used but sometimes misleading measure of volatility. To calculate a stock’s beta, an index like the S&P/TSX Composite or the S&P 500 is assigned a beta of 1.0. The historical volatility of different stocks relative to the index is then measured using either a 36-month or 60-month regression analysis.
If a stock has a beta of 1.0, then it means that the market and the stock move up or down together, at the same rate. That is, a 10% up or down move in the stock market index should theoretically result in a 10% up or down move in the stock. A beta of 2.0 implies the stock will tend to move twice as much as the market. That is, if the market moves up 10%, the stock should move up 20%. A beta of 0.5 indicates the stock will move one-half as much as the market, either up or down. The BMO Low Volatility Canadian Equity ETF relies on the scoring of individual stocks it holds to maintain the fund’s overall low volatility.
ETF: Beta scoring has a number of limitations
A negative beta indicates the stock tends to move in the opposite direction from the general market. That is, the stock price declines when the overall market is rising, or rises when the overall market is declining.
Inner Circle: Here’s why we don’t like the low-beta strategy of BMO Low Volatility Canadian Equity ETF
As a measure of risk, beta has a number of limitations. It is based on past data, so its use in predicting the future assumes that the underlying company being charted remains unchanged. For example, it assumes that no major acquisitions or divestitures, or other company-changing events take place. In reality, a stock’s beta can rise or fall over a period of years, or change abruptly.
Beta can mislead you in other ways. Gold stocks have an average beta of 0.70 when you use the S&P 500 Index as their benchmark index. Such a low beta indicates that gold funds are safe investments, like utilities. But they are not, of course, and that’s because their performance and returns have relatively little to do with the performance and returns of the S&P 500 Index. They rise and fall with gold prices.
Institutional investors are always looking for so-called “quantitative” measures like beta that can be calculated automatically by a computer program. Beta makes a broad statement about a stock’s history of volatility, but it doesn’t say much if anything about its prospects or its appeal as an investment. To assess a company’s suitability for your portfolio, you are better off using other, more reliable measures of safety, such as steady earnings and cash flow, low debt and a secure hold on a growing market.
Recommendation in Pat’s Inner Circle: The BMO Low Volatility Canadian Equity ETF is not recommended.