ETFs with Few Holdings… What's the point?

Jonathan Chevreau notes on his Wealth Boomer blog that BMO has launched 8 new ETFs to complement the 4 they launched earlier this year. I took a look at the new kids on the block and immediately I gravitated towards ZEB.to which seeks to track the S&P/TSX Equal Weight Diversified Banks Index. This ETF has an MER of 0.55% and it holds only six stocks in equal positions: BMO, CIBC, Royal Bank, Scotia, TD and National Bank.

As Norm Rothery pointed out in a Wealthy Boomer video interview, with the advent of discount brokerages you might be better off buying the underlying stocks yourself. For example, suppose you had $100,000 to invest in this strategy. You could either spend $10 per order x 6 orders = $60 to buy an equal weight starting allocation to these six stocks, or you could pay $10 for one order of the ETF. If we assume that this basket of stocks grows at a compounded rate of 8% for 10 years, the MER would’ve taken roughly another $8,000 from your portfolio in fees.

So on one hand, we have $60 to execute this strategy versus about $8,000.

Some may argue that there are benefits to rebalancing to consider. Fine – take the dividends as cash and once per year put the accumulated cash into the worst performing bank stock. This adds $10 per year for a total of $150 instead of $60.

Still not satisfied? Even if you fully rebalanced to an equal weight on a quarterly basis (which I think most would agree is excessive) the ETF would be more than 10 times more expensive than just buying the underlying holdings.

I think narrow ETFs for the most part might only be useful for market timers looking for specific sector beta for short periods of a time. (Beta means market exposure, essentially.)

For those of you who are interested, here is Jon’s interview with Norm Rothery in which they talk about how $10 trades was a game-changer. Note, they also talk about the disadvantage of cheap trades, too. :)

Preet Banerjee
Preet Banerjee
...is an independent consultant to the financial services industry and a personal finance commentator. You can learn more about Preet at his personal website and you can click here to follow him on Twitter.
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Showing 12 comments
  • Ink-stained gorilla

    The passive index market in Canada seems to be hitting a saturation point. I’m doing some work on ETFs right now and the market cap of the ETF industry is really only across a few mandates.

    Investors need to keep in mind that the threshold for an ETF to be profitable is $100 million in AUM. If it doesn’t reach that in a couple of years, expect it to be turfed.

  • Ink-stained gorilla

    I meant to say $50 million as the threshold. Anything that’s stayed under $40 million – be careful.

  • DH

    BMO is looking out for themselves. Thanks for going into this more in depth. It’s things like these that turn me off to anything that the big banks offer. They probably make most of their money off their own banking clients or like an RRSP group where you can only choose different funds/etfs from one bank.

  • DH

    BMO is looking out for themselves. Thanks for going into this more in depth. It’s things like these that turn me off to anything that the big banks offer. They probably make most of their money off their own banking clients or like an RRSP group where you can only choose different funds/etfs from one bank.

  • WestcoastFP

    Keep in mind that the $10 trade requires a minimum account size of $100,000 with Bmo’s direct investing arm. For those with less funds the ETFs good be a good option. However, stay away from any newly issued ETFs until there is sufficient liquidity. Lack of liquidity will lead to large bid -ask differentials if you need to sell. Best to stick with Claymore or iShares until the Bmo ETFs gather more steam.
    On another note this makes good biz sense for BMO as investing can be zero sum game. If you don’t invest in mutual funds at 2% then you will probably invest in the cheaper ETFs. As a producer, better to own a piece of both markets to hedge your bets.

  • Preet

    @WestcoastFP – good point. I have a feeling their ETFs will be used more for the next generation of managed portfolios as opposed to being a force within the DIY community.

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