An aggressive twist on a passive strategy|
Rudy Luukko • The National Post • January 18, 2001
Commonly thought of as middle-of-the-road vehicles, index funds as a group are evolving into something more. Now that all of the obvious categories of index funds have been covered off, the trend this year will be to introduce more esoteric types.
Over the coming months or years, you can expect to see new index funds that will invest in less efficient markets, or in small to mid-sized companies, or that focus on volatile industry sectors.
Barclays Global Investors Ltd., for instance, is poised to roll out eight new exchange-traded index funds that will include a Canadian mid-cap index fund, and sector funds specializing in technology, energy, financial-services and gold mining.
Others, such as indexing rivals CIBC Securities Inc. and TD Asset Management Inc., are likely to continue to expand their offerings. The more aggressive types of index funds, many of which are already cropping up in categories such as emerging markets, will reinforce the notion that passive investing strategies are not necessarily for passive investors.
Since these funds are not core investments, they will require more careful consideration on the part of investors as to where they fit into the portfolio picture, if at all.
Even within the mainstream categories of index funds, such as those that track the Toronto Stock Exchange 300 composite index or the Standard & Poor's 500 index, the events of the past year have been a wake-up call.
Indexing, per se, is not necessarily a conservative strategy. Even within a single market, such as the United States, the choice of which type of index fund to buy can have an immense impact on returns.
The CIBC U.S. Equity index fund, which tracks the very broadly based Wilshire 5000 index, returned -7.2% last year, while the technology-heavy CIBC Nasdaq index fund plunged 34.9%.
"If you believe in the philosophy of indexing, you should index the broadest market possible," says Ted Cadsby, president and chief executive of CIBC Securities. "Otherwise you're making a bet on different sectors or stocks."
For that reason, the Wilshire 5000, which encompasses about 99% of U.S. market capitalization, is his favourite U.S. index. Mr. Cadsby, who is the author of The Power of Index Funds, says the S&P 500, which covers about three-quarters of the U.S. market, is the "next best bet" for indexers.
Similarly, he chooses the TSE 300 over the large-cap S&P/TSE 60. The TSE 300 covers about 90% of the Canadian stock market, compared with about 70% for the 60-stock index. "If you're not holding 30% of the market, what if that 30% happens to be the best-performing part?" he asks.
The ability to make market calls is, however, one of the main rationales behind the proliferation of index funds into more specialized categories. They allow you to make a one-stop investment in a particular geographic region, such as Japan or Europe, or in a particular market-cap or industry segment, rather than an individual company.
"Indexing may be appropriate anywhere that you don't have a view on a specific stock," says Steve Rive, general manager for iUnits at Barclays Global Investors Canada Ltd.
Still, indexing works better in some markets than in others. The U.S. market is widely acknowledged as the best in which to employ index-based approaches. It is the world's largest, most liquid and widely watched market.
The Canadian market is fairly efficient, according to Enrique Cuyegkeng, managing director of Quantitative Capital, a division of TD Asset Management Inc. Although it still lags its much larger U.S. counterpart, he says, the liquidity of the Canadian market has "improved quite substantially" over the years.
However, indexing the Canadian market can be problematic, in part because of the heavy weighting of Nortel Networks Corp. The stock recently held a still-hefty 19% weighting in the TSE 300. Over the past year, the stock's weighting has been as high as 35%.
"You have to consider your total exposure to Canada and determine whethe players and trading activity.
Mr. Cadsby holds the strongest pro-indexing view. His firm's newest offerings include CIBC Asia Pacific index fund and CIBC Emerging Markets index fund, both launched in September.
"There aren't any markets where I would say: Don't index," notes Mr. Cadsby. "There's no market where you can say definitively that every active manager is going to beat the index."Rudy Luukko is a Toronto financial writer specializing in investment funds and is a regular contributor to the Financial Post. He can be reached at firstname.lastname@example.org