Let the great Canadian ETF smackdown begin.
In one corner we have the challenger, Claymore Investments, a relative newcomer to the exchange-traded fund sector here that has a growing and innovative lineup of products.
In the other corner we have Barclays Global Investors, which operates the iShares series of ETFs. The iShares lineup is popular and proven. Call it the heavyweight champion in attracting investors who appreciate the attributes of ETFs, which are low-cost index funds that trade like stocks.
Ideally, a long-term comparison of the returns generated by the two ETF families would be in order. But Claymore hasn't been in Canada long enough to draw any definitive conclusions about its particular style of index investing. So let's take a different tack and look at the performance of the two ETF families over the past 12 months.
What we get in the end is both a stress test of the two ETF lineups under harsh stock conditions, as well as some important insights into the differences between the Claymore and iShares approaches to indexing.
We'll compare Claymore and iShares ETFs in five categories: Canadian equity, U.S. equity, international equity, Canadian dividend and energy. Both ETF families have many more products, but these are the ones where it's possible to get the most meaningful comparisons.
No clear winner emerges in this evaluation, which is a plus because investors too often make choices based on short-term performance. The proper use of this comparison is to learn about the indexing styles used by Claymore and Barclays and how they affect performance in different types of markets.
It's clear that the past year has featured the kind of conditions that generally favour the traditional approach of the iShares family, which bases its ETFs on indexes where stocks are assigned weightings according to their market capitalization. This is basically a size measurement that is derived by multiplying a company's share prices by the number of shares it has outstanding.
With an index based on market capitalization, you get decreasing exposure to weak stocks like the big banks (as their share prices drop, so do their market caps), and you get increasing exposure to fast-rising market leaders like Research In Motion, Potash Corp. of Saskatchewan and various resource companies. In fact, RIM and Potash accounted for 11.1 per cent of the popular iShares Cdn LargeCap 60 Index Fund on June 30.
“To me, market cap-weighted indexing represents market sentiment,” said Heather Pelant, director of iShares in Canada. “For the last 40 years, everyone has been trying to poke holes in it, but they keep coming back to this being the most transparent way to capture the essence of the market.”
Claymore is in the group that thinks it has found a better way to index. Its fundamental indexing process takes the stocks in a particular index and weights them not by market cap, but by a combination of revenues, dividends, book value and cash flow.
Fundamental indexing costs more, a point you'll see reflected in the comparative fees to own Claymore and iShares products. But there are deeper differences, the most important being that fundamental indexing means fast-rising stocks like RIM and Potash get less emphasis than those with favourable financial characteristics and lower valuations. Investors may not like financial stocks much these days, but their solid underpinnings have given them a huge 41.2-per-cent weighting in the index tracked by Claymore Canadian Fundamental Index ETF. Meanwhile, RIM and Potash accounted for 1.8 per cent of the index last month.
Get the picture? Claymore's fundamental indexing accentuates value – stocks that have strong foundations but are out of favour – more than growth stocks. “Looking at our returns, they're going to underperform in a highly growth-dominated market like we've seen in the past 12 months,” said Som Seif, president of Claymore Investments.
The flip side is that Claymore funds offer the potential to outperform at a time when the market falters and high-flying stocks fall long and hard. But it isn't a slam dunk. Just take a look at the margin by which its US Fundamental ETF C$ Hedged has underperformed the iShares Cdn S&P 500 Index Fund in the past year, a period in which the S&P 500 stock fell 11 per cent.
Part of the explanation, again, is that the fundamental indexing style has given Claymore's U.S. fund a marked tilt toward hard-hit U.S. financial stocks – 21 per cent compared with 14.2 per cent for the iShares fund at midyear. Beyond the exposure to hard-hit banks, the explanation lies in the fact that the current market downturn in the United States is different than most in that it has been driven by the financial shocks caused by the problems in the U.S. housing sector. Undervalued, overlooked stocks usually outperform in down markets, but investors just aren't buying these companies now because they're so worried about risk.
Claymore's approach appears to work better when applied outside North America. Both the Claymore International Fundamental Index ETF and the competing iShares Cdn MSCI EAFE Index Fund have lost money in the past year, but the iShares fund has fallen further. Much of the reason is that the iShares EAFE fund is hedged to screen out the impact of moves in the Canadian dollar, while the Claymore International ETF is not. With the loonie weakening this year, unhedged funds have the advantage. Note: both the Claymore and iShares U.S.-market ETFs use hedging.
Claymore has also outperformed in the Canadian dividend category, where its Canadian Dividend & Income Achievers ETF has lost significantly less than the iShares Cdn Dividend Index Fund. Mr. Seif said Claymore's indexing strategy has produced a more diverse portfolio of companies that in this particular case is less dominated by financials. The iShares dividend ETF had almost 54 per cent of its portfolio in banks, insurers and fund companies as of midyear, while the Claymore fund was at 42.4 per cent.
Another differentiator is that Claymore's ETF includes income trusts, while the iShares counterpart does not. Trusts have helped beef up the Claymore fund's exposure to energy, which has helped performance over the past year.
Energy ETFs are the final point of comparison between the Claymore and Barclays families. The more diversified, sector-wide iShares approach has delivered slightly better returns than Claymore's focus on companies active in Alberta's oil sands.
If you're keeping count, the iShares family wins this smack-down with three victories to Claymore's two. But if this comparison tells us anything, it's that you have to go beyond performance data to choose between these two ETF competitors.
© The Globe and Mail
