Weekend Reading: Home Ownership Sucks Edition

By Robb Engen | July 25, 2021 |
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Weekend Reading: Home Ownership Sucks Edition

For many Canadians, owning a home is a sign of personal and financial success – a rite of passage signalling that you’ve made it on your own (maybe with some help from mom & dad). Just over two-thirds of Canadian households own their home, which puts us ahead of countries like the United States, Australia, and France, but well below the likes of Italy, Spain, and Norway.

Soaring real estate prices across the country have kept housing top of mind. Ask any journalist or blogger what the most-read stories are and they’ll invariably say anything to do with housing.

I must admit I don’t quite get the obsession. Maybe it’s because I can be an emotionless robot when it comes to financial decision making. Or because I live far away from the major Canadian cities where real estate has exploded in value. Here in Lethbridge, our housing market barely keeps pace with inflation.

YoY Change in Housing Prices

Or maybe it’s because, as Canada’s worst handyman, I’m keenly aware of the constant maintenance and upkeep that comes with owning a home. We moved into our current home – a brand new build – 10 years ago. In that time we’ve had to deal with an insurance claim for major roof and siding damage, plus landscaping projects, plumbing issues, appliances breaking down, a basement renovation, and an ant colony from hell, just to name a few. Yeah, home ownership sucks.

That’s why this piece from friend-of-the-blog Kyle Prevost resonated with me. Kyle moved to Doha, Qatar last summer to teach at an international school. Now he’s decided to sell his home in rural Manitoba. This quote nicely sums up my feelings around home ownership:

Endless fear of hearing a strange noise. Is that the furnace taking its last breath? Perhaps it’s the water treatment system deciding to spring a leak? Is that rain I hear – is it possible our septic system is backing up?!”

I acknowledge that I’m saying this from the privilege of being a long-time home owner (~20 years). I live in a low cost of living area and so it’s hard to put myself in the shoes of someone looking to buy a house today in a city where prices have increased by 30% or more year-over-year. The average home price in Lethbridge ($319,503) is less than half the average home price in Canada ($679,051). That’s insane.

We have serious housing affordability issues in many areas of the country where the answers seem to be:

  1. Rent forever
  2. Get a significant cash gift from relatives
  3. Move to a lower cost of living area

The last two just aren’t options for many aspiring home owners.

That’s why we need to destigmatize renting in this country. Renting doesn’t mean you’re a financial failure. In many cases it’s the smart financial decision. Renting is often cheaper, comes with fewer headaches, and gives you flexibility to relocate or travel for extended periods. 

Meanwhile, home ownership isn’t all that it’s cracked up to be. Condo owners pay monthly fees and also may be hit with special assessments from time-to-time. Detached home owners have to deal with all the crap I’ve mentioned above, with maintenance costs easily surpassing 1% of property value each year over the long term.

This Week’s Recap:

I recorded an interview with Kyle Prevost on investing FOMO for this year’s Canadian Financial Summit. The annual online financial conference should go live later this fall. I’ll keep you posted.

I’ll also be chatting with Kornel Szrejber this week about pensions on the Build Wealth Canada podcast. Stay tuned for that conversation.

On Monday I looked at the Vanguard effect on mutual funds, fees and performance.

On Thursday I dove further into the mutual space and revealed the dirty little secret of the industry – closet indexing

From the archives: Here’s Ben Felix on renting in retirement.

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Weekend Reading:

Our friends at Credit Card Genius have done the math to determine which Canadian rewards program is worth the most in categories like North American flights, long haul flights, free hotel stays, and groceries and gas.

Global News’ Erica Alini explains why some used cars are now selling for as much as new models.

The Humble Dollar’s Jonathan Clements debunks six playground taunts seen often on financial forums and blogs.

Downtown Josh Brown says your mission is to invest for the long-term. The world will offer you a million chances to fail that mission.

Morgan Housel explains why the highest forms of wealth are measured differently:

Keep two things in mind:

Desiring money beyond what you need to be happy is just an accounting hobby.

How much money people need to be happy is driven more by expectations than income.

Here’s Nick Magguilli on how investing has evolved from something only done by the rich and powerful to something done by everyday people.

PWL Capital’s Ben Felix explains the 5% rule when contemplating renting versus buying a home:

Jamie Golombek looks at a recent case involving a Vancouver taxpayer who purchased, demolished, constructed and then sold three homes in a six-year period.

Louise Cooper explains why women in particular have their work cut out when it comes to funding their retirement, but are generally better at investing than men are.

Preet Banerjee went off the record with Peter Mansbridge for his 100th (and possibly final) episode of the Mostly Money podcast. It was a good one!

A Wealth of Common Sense blogger Ben Carlson explains why hedging inflation is harder than it sounds:

“Markets always require context but the biggest lesson here is how hard it can be to hedge against short-term risks in the markets.”

Squawkfox blogger Kerry Taylor, who lives near Vernon, BC, describes her evacuation plan as wildfires rage nearby.

Finally, why waiting for baby boomers to die is not effective housing policy.

Enjoy the rest of the weekend, everyone!

Closet Indexing: Revealing The Dirty Little Secret Of Canada’s Mutual Fund Industry

By Robb Engen | July 22, 2021 |
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Closet Indexing: Revealing The Dirty Little Secret Of Canada's Mutual Fund Industry

For years I’ve railed against Canada’s mutual fund industry for high fees, conflicts of interest, underperformance, poor disclosure, and lack of accountability. But today I’m going to zero-in on another major problem with mutual funds in Canada – closet indexing.

Canadian equity mutual funds sold by Canada’s big banks, in particular, are some of the biggest offenders. The CIBC Canadian Equity Fund (CIB479) closely resembles the S&P/TSX 60 Index – a fund made up of Canada’s largest companies. The fund does not attempt to differentiate itself from the index, yet it charges a management expense ratio (MER) of 2.20%.

The 10-year performance of the S&P/TSX 60 Index is pretty solid with an annual average return of 7.97% (June 30, 2021). A passively managed Canadian equity ETF like iShares’ XIU with an MER of 0.18% returned 7.80% per year over 10 years.

But CIBC’s Canadian Equity Fund returns have been abysmal by comparison, at just 5.70% per year for the decade.

Is that surprising? It shouldn’t be. A fund that makes no meaningful attempt to differentiate from the index stands no chance of beating its benchmark. It makes an already difficult task (beating the market) impossible. Add a grossly expensive 2.20% MER and you have a closet indexing laggard.

CIBC’s fund is a bit player in the market, with assets under management of around $595 million. By comparison, TD’s Canadian Equity Fund manages $5.8 billion in assets. It’s a cash cow for TD and its advisors, charging a similarly outrageous 2.19% MER.

The fund holds 60 large-cap Canadian companies and once again makes no real attempt to stand out from the broader Canadian index. The result? An annual return of just 5.30% over the same 10-year period.


Canada’s Closet Indexing Problem

“If you deliver index-like returns, you should charge index-fund-like fees.”

That’s what American researchers concluded in 2015 when they revealed that the Canadian mutual fund industry is the world leader in closet indexing. Estimates showed that about 37% of the assets in equity mutual funds sold in Canada are in closet index funds.

The key takeaway here is that if your portfolio is made up of mutual funds sold to you by your bank advisor, it’s highly likely that they’re closet index funds. Closet indexing means you’re paying higher fees than necessary while getting less than your fair share of market returns.

Not all mutual funds are bad, however. Index mutual funds, for example, track a broad stock index such as the TSX or S&P 500. Returns mimic the stock market index, or benchmark, that the fund tracks, minus a small management fee. On the flip side, some mutual funds attempt to beat returns from a broader stock market index by taking a more active role in selecting stocks and timing the market.

Related: The Vanguard Effect On Mutual Funds, Fees, and Performance

Firms such as Mawer have had a successful long-term track record in large part because their holdings differentiate from the index that it’s trying to beat. Mawer’s Canadian Equity Fund (MAW106) has delivered returns of 9.50% annually over the last decade, compared to the S&P/TSX Composite Index, which returned 7.97% over the same period.

The jury is out as to whether Mawer can continue this outperformance into the future, but the company has two things going in its favour.

For one, Mawer charges relatively small fees for its mutual funds. The Canadian equity fund, which manages $823 million in assets, charges 1.17% MER, which is more than a full percentage point lower than what the closet indexing big bank mutual funds charge.

The second advantage Mawer has over the big banks is that its funds tend to have a high active share, an indicator which measures how much a fund’s portfolio deviates from its benchmark.

A fund with an active share of 0 is identical to the underlying index (i.e. a closet indexer), whereas a fund with an active share of 100 has nothing in common with the index.

In Mawer’s Canadian Equity Fund you’ll find the usual suspects such as Shopify, RBC and TD, Telus, CP and CN Rail. But the fund is limited to 46 holdings instead of 60-62, and within it you’ll also find smaller firms like Ritchie Bros, Stella-Jones, and Richelieu Hardware, to name a few.

These smaller, more concentrated bets help differentiate Mawer’s fund from the big banks’ closet indexing funds. 

Note that a passive investing approach is significantly more likely to deliver better and more reliable returns over the long term. A past successful track record is no guarantee of future success. The point is if you want to bet on the very small chance of outperforming the market then you’ll need to avoid a closet index fund and choose something that is different than the index.

Final thoughts

Canadian investors pay too much and get too little in return. Closet indexing is one of the main reasons why. All of the banks have index mutual funds in their line-up, but your advisor has little incentive to even mention them to you. That’s because it’s “suitable” to sell you a higher fee closet index fund, even though it’s in your best interest to pay less and get better returns.

DIY investors have more options. Index ETFs track the broader stock market and most charge even less than the cheapest index mutual funds. Stock pickers can follow a dividend growth or value strategy to mimic their own Mawer fund, minus the management fee.

The bottom line is that if you discover your portfolio is filled with nothing but closet indexing mutual funds, ask your advisor about a lower cost index fund solution, or switch to a robo-advisor that can manage a low-cost portfolio of index ETFs on the cheap.

Finally, if you’re comfortable enough to go it alone, open up a discount brokerage account and find an investing strategy that works for you.

The Vanguard Effect on Mutual Funds, Fees and Performance

By Robb Engen | July 19, 2021 |
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The Vanguard Effect on Mutual Funds, Fees and Performance

Vanguard is best known in Canada for its low cost, passively managed ETFs. Indeed, since entering the Canadian market in 2011, Vanguard now boasts a line-up of 37 ETFs with more than $40 billion in assets under management – making it the third largest ETF provider in Canada.

Keeping costs low is in Vanguard’s DNA. Their low fee philosophy hasn’t only benefited investors in Vanguard ETFs – it’s helped drive down costs across the Canadian ETF industry. This process has come to be known as the “Vanguard Effect”.

The cost of Vanguard ETFs is 54% lower than the industry average. Since 2011, they’ve cut their ETF’s average MER by almost half – saving their investors more than $10 million.

The Vanguard effect has made a noticeable difference for ETF investors in Canada, but the vast majority of Canadian investments are still held in actively managed mutual funds.

  • Mutual fund assets totalled $1.896 trillion at the end of May 2021.
  • ETF assets totalled $297.4 billion at the end of May 2021.

The Vanguard Effect on Mutual Funds

Vanguard took aim at the Canadian mutual fund market three years ago with the launch of four actively managed funds, including the Vanguard Global Balanced Fund (VIC100), the Vanguard Global Dividend Fund (VIC200), the Vanguard U.S. Value Windsor Fund (VIC300) and the Vanguard International Growth Fund (VIC400).

These funds have gathered about $630 million in assets and are available to fee-based clients as F-Series funds, and to DIY investors through the Questrade and Qtrade online brokerage platforms. F-Series funds do not include embedded or trailing commissions back to the advisor.

TickerNameCategoryManagement FeeMER
VIC100Vanguard Global Balanced Series FGlobal Equity Balanced0.34%0.54%
VIC200Vanguard Global Dividend Series FGlobal Equity0.30%0.48%
VIC300Vanguard Windsor U.S Value Series FUS Equity0.36%0.54%
VIC400Vanguard International Growth Series FInternational Equity0.40%0.58%

With three years under their belt in the Canadian mutual fund space, I thought I’d check in on the performance of Vanguard’s mutual funds.

While investors can’t glean much over a three-year period, the Vanguard funds have performed well compared to their benchmarks and industry peers.

  • Vanguard Global Balanced Fund (VIC100): +9.28% – VIC100 is a global balanced strategy with a strategic mix of 35% fixed income and 65% equities. It was designed to mirror the Vanguard Global Wellington Fund offered in the US – a 5-star rated fund by Morningstar. VIC100’s returns place it in the first quartile of its Global Equity Balanced category since inception.
  • Global Dividend Fund-Series F (VIC200): +6.06% – VIC200 invests in higher dividend yielding securities across the globe. Its style has been out of favour for most of the time since inception as markets have preferred high growth companies that don’t pay dividends. That has changed Year-to-Date (YTD), and VIC200’s returns are in the first quartile of its Global Equity category.
  • Windsor U.S. Value Fund-Series F (VIC300): +11.28% – VIC300 is the sister fund to the Vanguard Windsor Fund, offered in the US. The fund offers exposure to US large and mid-cap value stocks. Its value orientation was out of favour for the last few years but it’s ahead of its Russell 1000 Value Benchmark after fees since inception. As value has roared back, the fund is in the first decile of the US Equity category in Canada YTD.
  • International Growth Fund-Series F (VIC400): +19.20% – VIC400 has been a top performing fund since inception. It offers exposure to stocks primarily outside of North America. It mirrors a fund of the same name offered to US investors since 1981. The US fund is rated 5-stars by Morningstar. VIC400 has outperformed its benchmark by 12% per year.

As of Jun 30, 2021 - Peers beaten in the fund's Morningstar category    
TickerNameCategoryAnnlzd 3 Yr% Peers beaten 3 Yr
VIC100Vanguard Global Balanced Series FGlobal Equity Balanced9.28%79%
VIC200Vanguard Global Dividend Series FGlobal Equity6.06%12%
VIC300Vanguard Windsor U.S Value Series FUS Equity11.28%30%
VIC400Vanguard International Growth Series FInternational Equity19.20%98%

I recently had the opportunity to speak with Tim Huver, Head of Intermediary Sales at Vanguard Investments Canada about the success of their mutual funds and what we can expect in the future.

Q: Tim, one of the unique features of Vanguard’s mutual fund line-up is its so-called fulcrum pricing where if the fund fails to meet its benchmark target then the management fee will go down. How has that worked so far?

A: To our knowledge, no other actively managed fund is structured in this manner. There’s typically a “heads I win, tails you lose” mentality in the mutual fund industry. We wanted to change that by offering a performance-based pricing structure where the price of the fund is adjustable based on outperformance or underperformance.

Quite simply, if the fund doesn’t perform as we expect, the investor pays less. If it does well, you pay a little more but it is still well below the industry average. So the structure of the fund aligns totally with investors.

We wanted to keep costs low by only offering the funds in F-Series with no trailer fee and no commissions, and to DIY investors through online brokers that offer mutual funds with no kick-back to the platform.

And, even though management fees are capped at 0.50%, the fee on our top performing fund (VIC400) has remained the same at 0.40%.

Q: Vanguard mutual funds have been available for DIY investors on the Qtrade and Questrade platforms? Have any other discount brokers come onboard?

A: Not at this time. We want to make sure our mutual funds are available without any trailer fees paid back to the brokerage (which would increase the total cost of the fund). DIY investors can purchase Vanguard mutual funds at Questrade and Qtrade.

*Note: Questrade charges $9.95 per mutual fund trade, while Qtrade offers commission-free mutual fund trades.

Q: I’m a big fan of low-cost investing through passively managed ETFs. In fact, I invest my own money in Vanguard’s All-Equity ETF (VEQT). How should passive investors think about Vanguard’s actively managed mutual fund line-up?

A: First of all, asset allocation ETFs are a great starting point (and in some cases a great end point) for many investors. We’re seeing a lot more active-passive investing combos, where investors who are comfortable with more risk are looking to low-cost active funds for diversification and to minimize dispersion of returns.

Vanguard brought its flagship products, best in-class managers, and size & scale to Canada at institutional pricing, and we feel this shows up in the growth and performance of these four funds.

Vanguard is one of the largest active managers in the world, with a strong belief that active and passive/index-tracking funds can play a critical role in a well-diversified investment portfolio. Globally, Vanguard manages over $2.1 trillion CAD in active funds. To put that in perspective, it is more than the entire Mutual Fund industry’s assets in Canada. In the U.S., Vanguard’s active investments were ranked #1 for 10 year- and for 5-year returns, according to Barron’s.

Q: I have to ask, is Vanguard looking to expand its mutual fund line-up in Canada? We have a global balanced, a global dividend fund, a US value fund, and an international growth fund. Any plans to add a Canadian equity fund or a bond fund?

A: We are definitely looking to expand the line-up but all I can say right now is to stay tuned.

Final thoughts

Canadians pay some of the highest mutual fund fees in the world, so it’s great to see Vanguard entering the mutual fund space and having success.

I’d love to see Vanguard expand its mutual fund line-up and take a bigger bite out of the $1.9 trillion that Canadians have invested in predominantly actively managed mutual funds. Bringing the Vanguard effect to Canadian mutual funds would be amazing for investors.

Meanwhile, fee-based clients can encourage their advisors to add the Vanguard mutual funds to their platform, and DIY investors using the Questrade or Qtrade platforms can trade the Vanguard mutual funds directly.

While the overwhelming odds are in favour of passive investors over the long term, active investors can improve their chances of success by following Vanguard’s formula of low costs, patience, and conviction in the process.

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