Blogs & Comment

Vanguard ETFs bring choice to the market, but be careful

With the arrival in Canada of Vanguard Group, investors have a lot more choices in ETFs, but there's such a thing as 'too much choice.'

The much-anticipated arrival of Vanguard Group Inc. to the Canadian ETF market is now a reality. This week the giant U.S.-based exchange-traded fund distributor, famed for the rock-bottom management fees it charges on its funds, launched its first stable of funds here in the Great White North. And, true to their reputation, the new Canadian offerings cost less to own on an ongoing basis.

So much less, in fact, that there is sustained chatter that Vanguard’s initiative is bound to drive other Canadian ETF providers to lower their management fees to remain competitive.

As one example, Vanguard’s MSCI Canada ETF, launched December 6, charges a management fee of just 0.09%, compared to the previous standard low on a similar Canadian ETF—the iShares S&P/TSX 60—of 0.15%. Granted, we’re only talking $6.00 of difference over a year on each $10,000 invested. On the other hand, the proportionate difference is quite large, especially being so low to begin with.

Lower management fees in general on ETFs is a good thing; how could they not be? As long as the razor-thin charges—think of it as revenue to the ETF distributor—don’t lead to new ETF issuances cutting corners to keep down expenses, this will be a bonus to us as retail investors. As well as, of course, institutional investors.

Lower fees are not the only current trend affecting the Canadian ETF market. Very recently a suite of ETFs was introduced that could be traded for zero commissions. So now, it would seem investors have a choice: pay a low management fee, or pay no commissions to buy and sell.

In fact, choice is rampant in today’s ETF world. One Canadian provider offers eight different ETFs on the already narrow niche of Canadian corporate bonds. How finely, I wonder, does the average retail investor need to slice and dice the Canadian corporate bond market with ETFs to get the exact right exposure in their portfolio?

Choice isn’t limited to just micro-sectors either. There are now actively-managed ETFs available. There are leveraged ETFs which give you double the return (or loss) of the underlying market. There are ETFs that effectively allow you to take a short position on the market. There are even leveraged short ETFs that gain 2% every time the market falls 1%, and vice versa.

Low fees are good, and greater choice is good. However, one thing I learned a long time ago in investing is that, just because you can, doesn’t mean you want to. Specifically, when the RRSP foreign content limit was raised from 5% to 10%, then from 10% to 20%, before it was eliminated entirely, guess what happened on each occasion, immediately following the increase in the limit? Exactly. One time, when Japan was popular, the limit was raised, investors bit, and the Nikkei promptly dropped from 12,000 to 9,000. Another time it was the Latin American debt crisis. Another time, the Indonesian/Asian crisis. All shortly after the limit was raised, and investors had piled their retirement funds into these zones, each hot at the time.

It’s the same here in Canada right now with ETFs. We have lots of choice—on fees, commissions, leverage, short, managed—but do we retail investors want to take those choices? Institutional investors need these alternatives and, let’s be frank, that’s why there has been all this slicing and dicing: the providers want to attract the big institutional money.

In my opinion, the more traditional ETF issues are really great products for retail investors. The term ‘traditional’ applies equally to the iShare and new Vanguard issue mentioned above. Traditional ETFs allow retail investors to buy and hold a broad market index with passive management for a low fee. Newer choices tend to take us away from that: zero commissions, for example, run counter to the buy and hold approach for which ETFs are so perfect.

You have a choice, retail investor, and that choice includes choosing not to choose.