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Active Manager Praises Passive Funds

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Next we will see cats lying with dogs.

In “ETF Expense Ratios Between Countries” [4], I looked at how the same fund can have widely different expense ratios depending on which exchange it was listed.

I read an interesting article that reinforces a key point I made. And adds a couple more worthy of note. 

In “Active Manager Praises Passive Funds” [5], Wilfred Hahn talks about the proliferation of exchange traded funds. A few interesting points:

Proliferation of Cost-Effective Investment Options

Ten years ago, Hahn recalls, there were only about 150 ETFs globally. Now, with nearly 5,000 ETFs in his investment universe of potential picks, there’s very little need to trade on overseas exchanges. Nearly all of the ETFs that the portfolios now hold are listed on either the Toronto Stock Exchange or U.S. exchanges. “That’s good news because it makes international investing more cost-effective,” Hahn says.

In 10 years, from 150 ETFs to 5000. A lot more investment options.

I looked at this issue of ETF proliferation [6]previously. More is not always better. You need to watch out for a few potential problems.

Maybe cost-effective for North American investors today. Over time, I expect to see the rest of the world’s developed markets improve their fund offerings. And the more competition, the better the cost structures in the funds. Good news for investors around the world.

ETFs Covering All Investment Needs

At least 75% of each portfolio will consist of core holdings in equities, fixed income and cash. Some or all of the remaining 25% may be held in more opportunistic investments, such as ETFs dedicated to specific commodities. Hahn and his colleagues have identified more than 60 asset types that can be held via ETFs.

ETFs allow for investing in a wide range of asset classes and subclasses.

Yet the bulk of Hahn’s portfolios remain invested in the three core asset classes. It goes to show that investors can do quite well without having to branch out into exotic or alternative investments. Focus on your core. As you accumulate significant wealth, then consider augmenting your portfolio.

A key reason why you probably do not need alternative asset classes?

Consider a very simple example in the TSX 60 [7]. The largest 60 stocks in Canada. You want real estate exposure? You got Brookfield Asset Management [8]. Oil and gas? Canadian Natural Resources [9]. Gold? Goldcorp [10]. Silver? Silver Wheaton [11]. Copper? First Quantum Minerals [12]. Nuclear energy and uranium? Cameco [13]. Agriculture and potash? Potash Corporation [14].

That is just one example for each. There are more for various alternative investments. Heck, you can even invest based on (the highly profitable) Canadian consumption of doughnuts (and low cost coffee [15]).

And given the countries where many of these companies operate and/or market their products, simply investing in the TSX 60 provides substantial global exposure.

Buying these 60 largest Canadian traded companies, you get more than mere plain-vanilla Canadian-centric equities. If you look at any major index around the world, you will see that the companies within typically cover a wide range of industries and world regions.

These major indices are very good for portfolio diversification. You may not need to supplement your core portfolio with alternative asset classes or geographic markets. Your home market index may provide adequate diversification.

As an investing aside, I prefer a broader Canadian index. For example, the TSX Capped Composite Index [16]. Whereas the TSX 60 covers about 73% of the Canadian equity market, the Composite covers 95% with 257 companies included. Slightly more diversification and exposure to companies and industries. For example, the Composite includes additional alternative asset classes like diamonds (Dominion Diamond [17]) and timber (West Fraser [18]).

ETFs Aid in Prudent Portfolio Management

Hahn seeks to avoid what he calls “classic” portfolio mistakes such as not enough diversification, too much risk and too little fixed income. His exclusive use of ETFs, as opposed to direct holdings in stocks and bonds, enables him to minimize company-specific risk.

Note that Hahn uses passively managed ETFs (i.e., pure index ETFs) to create tactically managed portfolios. That is very different than an actively managed ETF [19]. And for more experienced investors, I have no issue with tactical asset allocation strategies [20]. I employ them myself in my business. More for longer term trends though than market timing.

For a look at strategic versus tactical allocation, Investopedia reviews a few styles [21].

Regardless of approach, index funds can definitely assist in enhancing portfolio diversification [22] and risk management [23] on a cost efficient basis.

It is what I recommend to you.

As your total capital and expertise accumulates, then consider expanding into non-traditional asset classes and possibly tactical asset management. But wait until your wealth grows. And more importantly, you develop strong investment knowledge and experience (or work with a competent financial advisor).