In This Issue

ETF PRICE WAR HEATS UP

By Gordon Pape

The iShares franchise, which is owned by BlackRock Asset Management Canada, dominates the ETF market in this country with an estimated share of about 80%. But a new player from south of the border is threatening to make things interesting.

U.S. giant Vanguard entered the Canadian market in 2011. Since then, it has accumulated more than $2.4 billion in assets under management. That’s an impressive accomplishment in a relatively short time. However, that only represents about 4% of the total value of all Canadian-based exchange-traded funds and is a drop in the bucket compared to BlackRock’s $44 billion.

You’d think based on those numbers that BlackRock would brush off Vanguard as nothing more than a bothersome fly. But here’s another statistic that explains why BlackRock and other ETF providers are worried. According to data published by the Canadian ETF Association, Vanguard has led all members in growth this year. As of the end of April, the company had added $589 million in assets so far in 2014, well ahead of runner-up BMO Asset Management, which added $484 million. And BlackRock’s iShares? They trailed the industry with $374 million in net redemptions during the first four months of the year.

There’s no secret as to why Vanguard is doing so well. In an industry where price is the main selling point, it aims to undercut its competitors by charging the lowest possible fees. That’s how the U.S. parent company, which was founded in 1975 by the legendary John Bogle, became a $2.5 trillion behemoth, including $345 billion in ETF assets. Vanguard Canada is simply following the same winning formula.

Now the Canadian firm is upping the ante with the launch of a new suite of five ETFs, which will bring their total offerings to 21. All will be based on existing U.S. Vanguard funds but will be domiciled in Canada and will trade on the TSX. The newcomers include a stock fund that invests throughout the world except Canada, two funds that focus on equities in developed European and Asia Pacific countries, a U.S. bond fund, and a global bond fund. The annual management fees of the new entries will range from 0.2% to 0.35%. The actual management expense ratios (MERs) will be slightly higher.

The current Vanguard line-up contains one fund with a bargain basement management fee of 0.09% (Vanguard FTSE Canada Index ETF), one at 0.12% (Vanguard FTSE Canada All Cap Index ETF), and six at 0.15%. The rest range in cost from 0.2% to 0.35%.

Vanguard’s rock-bottom prices and fast-growing assets have shaken up the rest of the industry. In late March, BlackRock Canada announced it was reducing fees on nine of its core ETFs. The biggest cut was to the popular iShares S&P/TSX Capped Composite Index ETF (TSX: XIC). It was sliced by 80%, from 0.25% to 0.05%, temporarily making it the cheapest ETF available in this country. Take that, Vanguard!

However, only about 10% of the iShares line-up took a haircut and the company still has many funds with management fees of 0.5% and higher. It will be interesting to see if more cuts are forthcoming if Vanguard continues to build market share.

BlakcRock isn’t the only company feeling the heat. About a month after the iShares announcement, BMO Asset Management made a similar move, reducing fees on seven of its ETFs, in some cases by more than 50%. The BMO equivalent of XIC, the BMO S&P/TSX Capped Composite Index ETF (TSX: ZCN) had its fee slashed by 67%, matching its iShares competitor at 0.05% and tying it for the cheapest fund in Canada. Two BMO S&P 500 funds, one hedged and the other unhedged, had their fees slashed to 0.10% undercutting the Vanguard equivalents by five basis points.

Obviously, all this price-cutting is great news for ETF investors. The lower the management cost of a fund, the more profit that is left for unitholders. But while all this has been happening, the much larger ($1 trillion) mutual fund industry has been sitting on its hands. Despite years of criticism that Canadian mutual funds are among the most expensive in the world, our fund companies appear to believe that the ETF price wars pose no threat to their dominance. We’ll see how that plays out in the long run.

Gordon Pape’s new book, RRSPs: The Ultimate Wealth Builder, is now available in both paperback and Kindle editions. Go to: http://astore.amazon.ca/buildicaquizm-20

 

SHALE GAS RESHAPES TRANSPORTATION SECTOR

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Contributing editor Tom Slee joins us this week with an intriguing look at how the shale gas bonanza is dramatically changing the North American transportation industry. Tom managed millions of dollars in pension fund money during his career and his expertise covers a range of sectors including stocks, fixed-income securities, and taxation. He lives in Toronto. Here is his report.

Tom Slee writes:

It’s hailed as a discovery but there is nothing new about shale gas. As early as 1821 people in Fredonia, New York started tapping low-pressure fractures to light the village. It was not until 1998, however, that major economic output was achieved by using slick-water fracturing. The rest, as they say, is history.

Production took off and by 2005 shale extraction was 5.9% of total U.S. gas production. By 2010 it was 23% and it could reach a staggering 49% by 2035. The energy landscape has been transformed and many North American industries have a new lease on life. As one commentator said: “There is new hope in the Rust Belt”.

Immediate beneficiaries of cheap, abundant shale gas include manufacturers, steel producers, and chemical companies. The fertilizer industry has been given a significant boost and, perhaps surprisingly, most of the North American transportation sector stands to gain. As a matter of fact, airlines, railroads, shipping, and trucking are already reaping the benefits of a shale gas boom. For some of the carriers there has been a dramatic and growing impact. A revival in North American manufacturing is providing more business while transportation costs are being significantly reduced.

Take trucking for example. These companies struggled in recent years because of clogged highways and border restrictions, while railways cut into their market share. Now, however, many of them are strategically placed to service the booming shale gas industry. A lot of production sites are small and remote, without access to a pipeline. So there is a huge demand for trucks to carry fresh water and sand into the project and then haul away waste and equipment. Truckers are also starting to benefit from increased activity as plants reopen and output picks up. At the same time, they are switching from expensive diesel fuel to natural gas to power the trucks, thereby reducing running costs. Clean Energy Fuels Corp. already has 150 liquid natural gas refueling stations open in 33 states and plans to expand its network.

Airlines too are flying people, supplies, and equipment into the more remote shale gas regions. In addition, they have accelerated research into using natural gas instead of the present jet fuel to fly their aircraft. This would reduce fuel costs, the airlines’ largest expense, and lower carbon dioxide emissions. It sounds like science fiction but this innovation may be closer than we think. Aviat Aircraft, a Minneapolis-based plane manufacturer, already has compressed natural gas powered aircraft in the air.

Shipping companies are planning for a huge surge in the liquefied natural gas (LNG) business. More than 20 proposed North American LNG export terminals are seeking permits to process about 30 billion cubic feet a day. Equally important, the marine shipping industry is turning to LNG to power its vessels. This is at least 70% less expensive than marine distillate fuel now in use and reduces sulphur and carbon dioxide emissions. Norwegian ferries are already running on gas and there are plans for worldwide gas bunkering facilities.

Railroads, my favourite transportation stocks, were early beneficiaries of the shale gas bonanza. Reactivated spur lines allowed them to supply isolated gas producers with chemicals needed in the extraction process. They were also able to carry away waste products. In some shale producing regions, railroads have been building additional infrastructure to keep up with demand. Rail is cheaper than trucking and more flexible than pipelines. At the same time, railways will benefit from an uptick in North American production spurred by shale gas: nearly 25% of the rapidly expanding chemicals output is transported by rail.

How do we play this gathering transportation groundswell? There are several ways but I think we should start by taking a look at how the sector has been performing this year. It’s a mixed bag, mainly because one of the harshest winters on record hampered North American rail and road activity during the first quarter. Volumes were down and there was upward pressure on costs, especially labour and equipment. The good news is that everything points to a rebound in business. U.S. economic figures are encouraging, forecasters expect another bumper harvest, and construction remains strong.

As to stocks, I think railways are still the best way to play the transportation industry. They continue to win market share from the trucking companies especially in the eastern United States. CN Rail (TSX: CNR, NYSE: CNI) is best-in-class and Norfolk Southern (NYSE: NSC), with the most upside potential, are both on our Buy List and my updates follow.

There are also some attractive looking stocks in the beleaguered trucking industry, despite downward pressure on shipping rates. Several companies have carved out special niches and instead of going head to head with the giant railroads they have adapted their operations to the new environment.

TransForce Inc. (TSX: TFI, OTC: TFIFF), one of our recommendations, is diversifying into waste management and parcel deliveries. Another freight transportation company adjusting to the market and generating earnings by operating in partnership with the railways is J.B. Hunt Transport Services (NDQ: JBHT). It’s my May Top Pick and the details follow.

 

TOM SLEE LIKES J.B. HUNT

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Founded in 1961 with five trucks for hauling rice, J.B. Hunt Transportation Services Inc. is now a Fortune 500 company operating throughout the U.S, Canada, and Mexico. Revenues of $5.6 billion in 2013 generated an operating profit of $830 million (all dollar amounts are in U.S. currency).

Hunt conducts its business in four segments: Intermodal (63% of revenues), Contract Services (19%), Truckload (9%), and Freight Brokerage (9%). With more than 16,000 employees, the company operates 12,000 trucks as well as 47,000 trailers and containers.

All of the divisions are profitable but the big story here is the intermodal (container) division. As a matter of fact, Hunt is known as a container rather than a trucking company.

Containerization revolutionized the transportation industry. For centuries people laboriously loaded, unloaded, and then re-loaded goods again as they were transferred from factories to trains to ships and then to customers. It was time consuming, expensive, and inefficient. Goods were damaged and pilfering was widespread. In retrospect you have to wonder why it took until the 1950s before trucking entrepreneur Malcolm McLean bought a steamship company and started transporting entire truck trailers with their cargo still inside. Others soon followed and container ships now carry more than 70% of the value of goods shipped by sea.

Intermodalism, which means shifting the same container by different forms of transport, was the next logical step and today cargo is moved seamlessly by transferring a container between trucks, trains, and ships in order to achieve door-to-door delivery. It’s a complex process that is still being refined and J.B. Hunt is on the cutting edge.

Instead of meeting the railroads head on and competing for long distance haulage, the company has entered into partnership agreements with most of the leading rail carriers and complements each end of their operations in order to meet customer needs. Hunt has gone even further, contracting with hundreds of major corporations such as Home Depot to provide them with customized freight movement using systems and delivery services tailored to meet their particular requirements. In this connection, Hunt has 87 “last mile” support locations.

My point is that JBH is not a conventional trucking company. It is a dominant presence in intermodal and logistical services and well placed to benefit from the expected growth in railway earnings as the recovery gains traction. The numbers are already impressive. Class 1 railroads reported average earnings growth of 8% in first quarter 2014 in spite of severe weather. Residential construction and auto output tailwinds are spurring highway/rail shipments and a tighter trucking market is expected to push rates higher.

Hunt reported earnings of $0.58 a share in the first quarter, down slightly from $0.61 in the previous year due to the bad winter and unusual start-up costs in the Contract Services operations. However, management noted that customer demand was returning to normal late in the period and there was top line growth with intermodal load increasing 5% and truckload volumes up 9% year-over-year.

Looking ahead, significant investments by the railroads designed to broaden their intermodal markets should provide Hunt with scope to generate well above average volume growth. Earnings of about $3.15 a share are expected this year, compared to $2.87 in 2013, with a jump to the $4 range in 2015.

Action now: J.B. Hunt is a Buy with a target of $88. I have set $68 as a revisit level. The shares were trading on Thursday at $76.56.

TOM SLEE’S UPDATES

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CN Rail (TSX: CNR, NYSE: CNI)

Originally recommended on May 6/02 (#2218) at C$12.98 (split-adjusted). Trading Thursday at C$63.70, US$58.55.

Shrugging off one of the worst winters on record, CN Railway turned in a respectable 2014 first quarter. Earnings of $0.66 a share were up 8.6% from an adjusted $0.61 in the same period of 2013 despite bad weather costing CN approximately $0.08 a share. The crucial operating ratio (the percentage of revenues needed to run the system) came in at 69.6%, still the best amongst Class 1 rails. There was solid volume growth and a free cash flow of $494 million during the period.

Perhaps most encouraging is the way CN is taking the difficult quarter in its stride. The company expects double-digit earnings growth in 2014 and a free cash flow in the $1.7 billion range. There is a record Canadian grain crop to support exports and the economic recovery is boosting intermodal traffic. Crude oil shipments are also trending higher. It all points to earnings of about $3.50 a share in 2014 and $4 or more next year.

CN Railway remains a cornerstone of our investment portfolio.

Action now: CN Rail is Buy with a target of $70. I will revisit the stock if it dips to $55.

Norfolk Southern (NYSE: NSC)

Originally recommended on Dec. 14/09 (#2944) at $52.22. Trading Thursday at $95.79. (All figures in U.S. currency.)

Norfolk Southern racked up earnings of $1.17 a share in the first quarter, slightly better than the $1.15 consensus forecast but down from $1.22 year-over-year due to lower coal shipments. Adverse weather was also a factor and cost the company about $50 million in revenues, although management estimates about $20 million of that was deferred and can be recaptured later in the year. The operating ratio declined slightly, less is better, to 75.2%. The company generated $207 million of free cash flow.

Looking ahead, Norfolk`s intermodal volumes are expected to surge in 2014 as traffic increases along its key corridors. Analysts expect a 10% increase in these shipments as new terminals at Greer, South Carolina and Charlotte, North Carolina come on stream. At the same time, conventional merchandise volumes should pick up as U.S. steel and automotive output increases.

As long as I can remember, Norfolk Southern has been regarded as a bulk carrier with its stock price largely governed by the price of lignite and soft coal. But that is changing. At the end of last year, merchandise shipments were accounting for 56% of the railroad’s revenues, while coal, a declining factor, contributed 22%. We should see this improving mix reflected in a higher earnings multiple for the stock.

Action now: Priced at $95.79, Norfolk Southern remains a Buy with a target of $110. I have set an $85 revisit level.

Finning International (TSX: FTT, OTC: FINGF)

Originally recommended on Aug. 31/09 (#2932) at C$16.61. Trading Thursday at C$30.04, US$28.12.

Finning International finished 2013 with a flourish. Earnings for the year came in at $1.95 a share versus $1.90 in 2012, with a free cash flow of $441 million. Revenues were a record $6.8 billion and the stock responded by trading close to $32. Since then, however, analysts have been concerned by reports that first quarter 2014 profits in Chile were far worse than expected. Management has released reassuring guidance but investors are nervous. Regardless of the initial numbers, foreign exchange is bound to be a headwind.

The shares, currently trading at $30.04, have performed well since our first recommendation at $16.61. Now, however, they appear to be fully priced and there is a question mark about the political and economic uncertainty in South America. I think it is time to take our profits.

Action now: Finning International is a Sell at $30.04. Including dividends of $2.39 a share we have a total return of 95%.

Stella Jones Inc. (TSX: SJ, OTC: STLJF)

Originally recommended on April 2/12 (#21213) at C$10.55 (split-adjusted). Trading Thursday at C$29.92, US$27.46.

Stella Jones traded at $32.74 in early April before pulling back to the current level. Still, we are up 184% from our original recommendation two years ago at a split-adjusted price of $10.55 and close to the $30 target. This is another company benefitting from the boom in railroads and I think the stock still has upside potential.

Action now: SJ remains a Buy with a new $37 target. I shall update the company in greater detail next time.

Alimentation Couche-Tard (TSX: ATD.B, OTC: ANCUF)

Originally recommended on March 4/13 (#21309) at C$17.62, US$17.13 (split-adjusted). Trading Thursday at C$29.60, US$27.35.

Alimentation’s stock split three for one in late April so you now own 300 shares for every 100 you had previously. At the current price of C$29.60, US$27.35, the stock is almost at my pre-split target of C$90 and continues to show strength. European margins are expected to jump this year and lift earnings. I will provide a full update soon but in the meantime I am raising my target to a post-split price of $37.

Action now: Buy.

– end Tom Slee


ZOMBIE BONDS

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Like zombies, bonds refuse to stay dead.

Everyone, including me, thought the long fixed-income bull market came to an end last May. That’s when bond yields took a huge leap in the wake of comments by former Fed chairman Ben Bernanke about tapering the quantitative easing (QE) program. Bond prices sagged across the board (prices and yields have an inverse relationship). For the first time in many years, most bond funds and ETFs lost money in 2013, in some cases more than 3%.

More of the same was expected this year. As the global economy gained strength, interest rates were expected to start rising, always bad news for bonds. Combine that with the Fed’s tapering program, which is now being implemented, and you have the ingredients for a repeat of 2013, or worse.

It’s not working out that way. As I noted last week, the OECD is now expecting slower growth this year than originally anticipated. The new chair of the U.S. Federal Reserve Board, Janet Yellen, has indicated that interest rates will remain low into 2015 and perhaps beyond. The European economy looks fragile, with first-quarter growth in the 18 euro countries coming in at only 0.2%. That has led to speculation that the European Central Bank may cut rates and take other action to stimulate the moribund economy at its June 5 meeting.

Here at home, there’s talk that the next rate move by the Bank of Canada may be down instead of up. Until recently, it was almost an article of faith that the BoC would begin raising its target rate, currently at 1%, later this year or in 2015. That’s no longer the slam dunk it appeared to be.

Unlike the U.S., the BoC has some room to cut and some economists believe that unless the growth rate picks up, the Bank could drop its rate by 25 basis points in the fall. That would, at least in theory, give a boost to the economy while pushing down the value of the Canadian dollar. A lower loonie works to the advantage of exporters and the energy sector, among others, and there’s a growing view that the Bank would like to see our currency somewhere south of US$0.90.

The result of these changing attitudes has been a resurgence in the bond market. As of the close of trading on May 14, the DEX Universe Bond Index was showing a year-to-date gain of 4.13%. Both corporate and government issues have been doing well with government bonds up 4.09% while corporates are ahead 4.21%. Provincial bonds have been especially strong, gaining 5.22%.

What I find especially interesting is that long-term bonds have done exceptionally well, gaining 7.68% year-to-date. This suggests that bond traders believe that low rates will remain in place for some time to come.

Mutual funds and ETFs have reflected this bond market rebound. Almost all of the funds in the Canadian Fixed Income category are comfortably in profit territory so far in 2014, with a few showing gains of over 4% for the year. Among long bond funds, all but one are showing gains of 5%+ so far. The BMO Long Corporate Bond Index ETF (TSX: ZLC) leads the way with an advance for the year of 7.23%.

The zombie-like bond recovery reminds us yet again to take nothing for granted when it comes to investing. There are always surprises. A balanced portfolio is the best way to deal with them.

 

GORDON PAPE’S ETF UPDATES

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iShares 1-5 Year Laddered Corporate Bond Index Fund (TSX: CBO)

Originally recommended on June 11/12 (#21220) at $20.24. Trading Thursday at $19.80.

This short-term bond ETF was recommended as a low-risk way to hold fixed-income securities and it continues to full that role very nicely. We’ve seen some erosion in the price but that has been more than compensated for by the monthly distributions we’ve received. These are currently running at about $0.07 per unit.

CBO showed an average annual compound rate of return of 3.1% over the two years to April 30. As of May 12, the year-to-date gain for 2014 was 1.7%, which is good for a fund of this type.

Action now: CBO is a Hold for conservative investors.

iShares Canadian Universe Bond Index ETF (TSX: XBB)

Originally recommended on March 5/07 (#2709) at $29.44. Trading Thursday at $30.89.

This bond ETF is down slightly from my last update in June 2013, at which time I advised reducing positions. However, it remains a decent fixed-income core holding because of its stability and steady cash flow – the current monthly payment is about $0.08 per unit.

The fund has changed its benchmark since the last review and now tracks the performance of the FTSE TMX Canada Universe Bond Index. This has resulted in a change in its name (previously it has tracked the DEX Universe Bond Index).

The fund had a weak year in 2013 losing 1.5% however it has recovered since and was showing a year-to-date gain for 2014 of almost 4%. That’s surprisingly strong and I doubt it can be maintained but it proves once again that there is always room for bonds in a portfolio.

Action now: Hold.

iShares BRIC Index Fund (TSX: CBQ)

Originally recommended on May 26/12 (#21212) at $27.36. Trading Thursday at $23.52.

It’s been a rough go for this fund. All four components have gone into the dumpster at the same time. Brazil’s economy has struggled, Russia has been hit by the escalating economic sanctions relating to its Ukraine policies, while China’s growth rate has slowed significantly and appears to have settled into a new, lower range. The one relatively bright spot has been India where the key index is up 12.8% year-to-date, largely on hopes that a new, pro-business government would be elected.

In short, the BRICs have lost their shine. As a result, these shares are down $3.84 from the original recommended price. We have received $1.28 in distributions, however, so our actual loss is 9.4%.

I dropped this fund from our TFSA Portfolio in March and now I suggest we also drop it from the Recommended List. Focus instead on the broader emerging markets or frontier markets.

Action now: Sell.

iShares MSCI Frontier 100 ETF (NYSE: FM)

Originally recommended on Feb. 10/14 (#21406) at $34.21. Trading Thursday at $37.98. (All figures in U.S. dollars.)

Speaking of frontier markets, we’ve had a nice run from our last review in March when I rated this fund as a Buy for aggressive investors at $34.93. Since then, we’ve seen a gain of $3.05 in the share price for an advance of 8.7%. We’re up 11% from the original recommendation in February.

However, there are some major changes coming. The fund is about to lose two of its biggest components, Qatar and the United Arab Emirates, which are being promoted to the MSCI Emerging Markets Index. They represent almost 38% of the ETF’s total assets, which means there is a huge hole that will have to be filled.

Russ Koesterich, chief investment strategist for BlackRock Capital, which owns the iShares franchise, tried to put a positive spin on this development in a recent note, saying: “My sense is that the new portfolio of companies in the index following the rebalancing will more accurately reflect what most people think of when they consider investing in frontier markets”.

That may be, but will they perform anywhere near as well? Investors in the fund will find they are holding larger positions in countries like Pakistan, Sri Lanka, and Vietnam. The sector mix will also change, with less exposure to financial stocks and more to consumer staples and energy.

The bottom line is that there is a lot of uncertainty about how the rebalancing will affect performance so my advice at this stage is not to add to positions until we get a better handle on the situation. Traders may wish to take their profits and exit now; otherwise maintain your position and watch.

Action now: Hold.

iShares Japan Fundamental Index Fund (TSX: CJP)

Originally recommended on April 29/13 (#21317) at $10.86. Trading Thursday at $10.78.

The bloom went off the Japanese rose very quickly. This ETF was trading in the $12 range at the beginning of the year but has since pulled back to close to our original recommended price as the Nikkei Index hit a soft spot, losing 11.5% year to date. A bounce back is always possible but my inclination is to exit this position in favour of better opportunities.

Action now: Sell.

iShares S&P 500 Index ETF (CAD-Hedged) (TSX: XSP)

Originally recommended on July 9/07 (#2725) at $19.22. Trading Thursday at $21.52.

New York’s S&P 500 Index has moved into record territory in recent weeks. That has given a big boost to this ETF, which had been bleeding red ink since the 2008-09 market crash. The one-year return of 21.6% (to April 30) looks good, but it was more than five percentage points below the average for the U.S. Equity category.

The reason for the relatively weak result is that this fund is hedged back into Canadian dollars. That works in favour of investors when the loonie is climbing against the U.S. greenback. But during periods when our dollar is in decline, hedging works against you.

Just over a year ago, BlackRock launched an unhedged stable mate to this fund, which trades under the symbol XUS. It has been the stronger performer so far this year, gaining 6.9% to May 13 compared to just 4.3% for the hedged version. The management fees for both funds were recently cut to a very attractive 0.1% so either is a good choice if you want exposure to U.S. large-cap stocks.

Many economists predict that the loonie will slide further over the coming year with some saying it could reach the US$0.80 range. I’m not that pessimistic but I think there is a strong possibility the loonie could slip to somewhere between US$0.85 and US$0.89 later this year. If you believe the Canadian dollar will fall, XUS is the better choice right now.

Action now: Hold. If you want exposure to potential gains in the U.S. dollar, switch to XUS.

iShares S&P/TSX Canadian Dividend Aristocrats Index Fund (TSX: CDZ)

Originally recommended on April 9/12 (#21214) at $22.29. Trading Thursday at $25.94.

This fund invests in Canadian stocks that have increased their dividends for at least five consecutive years and have a market cap of $300 million or more. You might think that would indicate a portfolio chock-full of large-cap stocks but you’d be wrong. Major holdings include AGF Management (5.4% of total assets), Exchange Income Corp. (3.5%), Enbridge Income Fund (2.9%), and Bird Construction (also 2.9%). The only true large-cap in the top 10 holdings is BCE Inc.

The fund pays monthly distributions, which started out at $0.06 per unit at the time of my recommendation and are now up to $0.06984. Since we first looked at this ETF we have received payments totaling $2.18. Combined with the capital gain, we have a total return of 26% in a little more than two years.

I continue to like this ETF but it’s important to understand exactly what you’re buying before you invest here. Take a look at the portfolio on the iShares website before making a decision.

Incidentally, this was not one of the iShares funds to benefit from the company’s recent price cuts. The management fee is 0.6% and the MER is 0.66%, which is on the high side for an ETF.

Action now: Buy.

YOUR QUESTIONS

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TFSA profits

Q – I just read your book about TFSAs. My question is: If I am a middle or high income person, regardless my age, with a self directed account, able to get returns over 25% a year, saving for my retirement, what would be the best for me? Should I take advantage of the $5,500 allowance in my TFSA and the put the rest in my RRSP or invest everything in my RRSP and forget about putting any money in my TFSA?

My question is because in the book you are conservative about the returns and it is not clear for me what would be better between an RRSP or a TFSA if you can get higher returns. – Juan B.
 
A – If you can consistently produce returns of 25% a year, perhaps you would like to share your secrets with our readers. It’s something we’d all like to know. As far as your question is concerned, making use of the TFSA should certainly be your first priority. Any profits in an RRSP will be taxed at your marginal rate when the money comes out. Withdrawals from a TFSA are tax-free. – G.P.

 

HOUSEKEEPING

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The following securities have been deleted from our on-line Recommended List. Sell advisories were issued some time ago so this notice is for record-keeping purposes only.

TEVA Pharmaceutical (NDQ: TEVA). Recommended by Glenn Rogers on July 19/10 at US$54.33. Sold May 13/13 at US$38.89.

Seagate Technology (NDQ: STX). Recommended by Glenn Rogers on April 23/12 at US$29.21. Sold May 13/13 at US$40.50.

Kirby Corp. (NYSE: KEX). Recommended by Glenn Rogers on July 11/11 at US$58.05. Sold Feb. 18/13 at US$75.03.

Fluor Corp. (NYSE: FLR). Recommended by Glenn Rogers on March 18/08 at US$68.27. Sold May 13/13 at US$61.91.

Dentsply International (NDQ: XRAY). Recommended by Glenn Rogers on Sept. 4/07 at US$39.38. Sold Oct. 22/12 at US$36.21.

 

That does it for this issue. The IWB will now go on hiatus for two weeks (we publish 44 times a year) while I take a much-needed vacation. Look for your next issue on June 9.

Best regards,

Gordon Pape

In This Issue

ETF PRICE WAR HEATS UP

By Gordon Pape

The iShares franchise, which is owned by BlackRock Asset Management Canada, dominates the ETF market in this country with an estimated share of about 80%. But a new player from south of the border is threatening to make things interesting.

U.S. giant Vanguard entered the Canadian market in 2011. Since then, it has accumulated more than $2.4 billion in assets under management. That’s an impressive accomplishment in a relatively short time. However, that only represents about 4% of the total value of all Canadian-based exchange-traded funds and is a drop in the bucket compared to BlackRock’s $44 billion.

You’d think based on those numbers that BlackRock would brush off Vanguard as nothing more than a bothersome fly. But here’s another statistic that explains why BlackRock and other ETF providers are worried. According to data published by the Canadian ETF Association, Vanguard has led all members in growth this year. As of the end of April, the company had added $589 million in assets so far in 2014, well ahead of runner-up BMO Asset Management, which added $484 million. And BlackRock’s iShares? They trailed the industry with $374 million in net redemptions during the first four months of the year.

There’s no secret as to why Vanguard is doing so well. In an industry where price is the main selling point, it aims to undercut its competitors by charging the lowest possible fees. That’s how the U.S. parent company, which was founded in 1975 by the legendary John Bogle, became a $2.5 trillion behemoth, including $345 billion in ETF assets. Vanguard Canada is simply following the same winning formula.

Now the Canadian firm is upping the ante with the launch of a new suite of five ETFs, which will bring their total offerings to 21. All will be based on existing U.S. Vanguard funds but will be domiciled in Canada and will trade on the TSX. The newcomers include a stock fund that invests throughout the world except Canada, two funds that focus on equities in developed European and Asia Pacific countries, a U.S. bond fund, and a global bond fund. The annual management fees of the new entries will range from 0.2% to 0.35%. The actual management expense ratios (MERs) will be slightly higher.

The current Vanguard line-up contains one fund with a bargain basement management fee of 0.09% (Vanguard FTSE Canada Index ETF), one at 0.12% (Vanguard FTSE Canada All Cap Index ETF), and six at 0.15%. The rest range in cost from 0.2% to 0.35%.

Vanguard’s rock-bottom prices and fast-growing assets have shaken up the rest of the industry. In late March, BlackRock Canada announced it was reducing fees on nine of its core ETFs. The biggest cut was to the popular iShares S&P/TSX Capped Composite Index ETF (TSX: XIC). It was sliced by 80%, from 0.25% to 0.05%, temporarily making it the cheapest ETF available in this country. Take that, Vanguard!

However, only about 10% of the iShares line-up took a haircut and the company still has many funds with management fees of 0.5% and higher. It will be interesting to see if more cuts are forthcoming if Vanguard continues to build market share.

BlakcRock isn’t the only company feeling the heat. About a month after the iShares announcement, BMO Asset Management made a similar move, reducing fees on seven of its ETFs, in some cases by more than 50%. The BMO equivalent of XIC, the BMO S&P/TSX Capped Composite Index ETF (TSX: ZCN) had its fee slashed by 67%, matching its iShares competitor at 0.05% and tying it for the cheapest fund in Canada. Two BMO S&P 500 funds, one hedged and the other unhedged, had their fees slashed to 0.10% undercutting the Vanguard equivalents by five basis points.

Obviously, all this price-cutting is great news for ETF investors. The lower the management cost of a fund, the more profit that is left for unitholders. But while all this has been happening, the much larger ($1 trillion) mutual fund industry has been sitting on its hands. Despite years of criticism that Canadian mutual funds are among the most expensive in the world, our fund companies appear to believe that the ETF price wars pose no threat to their dominance. We’ll see how that plays out in the long run.

Gordon Pape’s new book, RRSPs: The Ultimate Wealth Builder, is now available in both paperback and Kindle editions. Go to: http://astore.amazon.ca/buildicaquizm-20

 

SHALE GAS RESHAPES TRANSPORTATION SECTOR

Contributing editor Tom Slee joins us this week with an intriguing look at how the shale gas bonanza is dramatically changing the North American transportation industry. Tom managed millions of dollars in pension fund money during his career and his expertise covers a range of sectors including stocks, fixed-income securities, and taxation. He lives in Toronto. Here is his report.

Tom Slee writes:

It’s hailed as a discovery but there is nothing new about shale gas. As early as 1821 people in Fredonia, New York started tapping low-pressure fractures to light the village. It was not until 1998, however, that major economic output was achieved by using slick-water fracturing. The rest, as they say, is history.

Production took off and by 2005 shale extraction was 5.9% of total U.S. gas production. By 2010 it was 23% and it could reach a staggering 49% by 2035. The energy landscape has been transformed and many North American industries have a new lease on life. As one commentator said: “There is new hope in the Rust Belt”.

Immediate beneficiaries of cheap, abundant shale gas include manufacturers, steel producers, and chemical companies. The fertilizer industry has been given a significant boost and, perhaps surprisingly, most of the North American transportation sector stands to gain. As a matter of fact, airlines, railroads, shipping, and trucking are already reaping the benefits of a shale gas boom. For some of the carriers there has been a dramatic and growing impact. A revival in North American manufacturing is providing more business while transportation costs are being significantly reduced.

Take trucking for example. These companies struggled in recent years because of clogged highways and border restrictions, while railways cut into their market share. Now, however, many of them are strategically placed to service the booming shale gas industry. A lot of production sites are small and remote, without access to a pipeline. So there is a huge demand for trucks to carry fresh water and sand into the project and then haul away waste and equipment. Truckers are also starting to benefit from increased activity as plants reopen and output picks up. At the same time, they are switching from expensive diesel fuel to natural gas to power the trucks, thereby reducing running costs. Clean Energy Fuels Corp. already has 150 liquid natural gas refueling stations open in 33 states and plans to expand its network.

Airlines too are flying people, supplies, and equipment into the more remote shale gas regions. In addition, they have accelerated research into using natural gas instead of the present jet fuel to fly their aircraft. This would reduce fuel costs, the airlines’ largest expense, and lower carbon dioxide emissions. It sounds like science fiction but this innovation may be closer than we think. Aviat Aircraft, a Minneapolis-based plane manufacturer, already has compressed natural gas powered aircraft in the air.

Shipping companies are planning for a huge surge in the liquefied natural gas (LNG) business. More than 20 proposed North American LNG export terminals are seeking permits to process about 30 billion cubic feet a day. Equally important, the marine shipping industry is turning to LNG to power its vessels. This is at least 70% less expensive than marine distillate fuel now in use and reduces sulphur and carbon dioxide emissions. Norwegian ferries are already running on gas and there are plans for worldwide gas bunkering facilities.

Railroads, my favourite transportation stocks, were early beneficiaries of the shale gas bonanza. Reactivated spur lines allowed them to supply isolated gas producers with chemicals needed in the extraction process. They were also able to carry away waste products. In some shale producing regions, railroads have been building additional infrastructure to keep up with demand. Rail is cheaper than trucking and more flexible than pipelines. At the same time, railways will benefit from an uptick in North American production spurred by shale gas: nearly 25% of the rapidly expanding chemicals output is transported by rail.

How do we play this gathering transportation groundswell? There are several ways but I think we should start by taking a look at how the sector has been performing this year. It’s a mixed bag, mainly because one of the harshest winters on record hampered North American rail and road activity during the first quarter. Volumes were down and there was upward pressure on costs, especially labour and equipment. The good news is that everything points to a rebound in business. U.S. economic figures are encouraging, forecasters expect another bumper harvest, and construction remains strong.

As to stocks, I think railways are still the best way to play the transportation industry. They continue to win market share from the trucking companies especially in the eastern United States. CN Rail (TSX: CNR, NYSE: CNI) is best-in-class and Norfolk Southern (NYSE: NSC), with the most upside potential, are both on our Buy List and my updates follow.

There are also some attractive looking stocks in the beleaguered trucking industry, despite downward pressure on shipping rates. Several companies have carved out special niches and instead of going head to head with the giant railroads they have adapted their operations to the new environment.

TransForce Inc. (TSX: TFI, OTC: TFIFF), one of our recommendations, is diversifying into waste management and parcel deliveries. Another freight transportation company adjusting to the market and generating earnings by operating in partnership with the railways is J.B. Hunt Transport Services (NDQ: JBHT). It’s my May Top Pick and the details follow.

 

TOM SLEE LIKES J.B. HUNT

Founded in 1961 with five trucks for hauling rice, J.B. Hunt Transportation Services Inc. is now a Fortune 500 company operating throughout the U.S, Canada, and Mexico. Revenues of $5.6 billion in 2013 generated an operating profit of $830 million (all dollar amounts are in U.S. currency).

Hunt conducts its business in four segments: Intermodal (63% of revenues), Contract Services (19%), Truckload (9%), and Freight Brokerage (9%). With more than 16,000 employees, the company operates 12,000 trucks as well as 47,000 trailers and containers.

All of the divisions are profitable but the big story here is the intermodal (container) division. As a matter of fact, Hunt is known as a container rather than a trucking company.

Containerization revolutionized the transportation industry. For centuries people laboriously loaded, unloaded, and then re-loaded goods again as they were transferred from factories to trains to ships and then to customers. It was time consuming, expensive, and inefficient. Goods were damaged and pilfering was widespread. In retrospect you have to wonder why it took until the 1950s before trucking entrepreneur Malcolm McLean bought a steamship company and started transporting entire truck trailers with their cargo still inside. Others soon followed and container ships now carry more than 70% of the value of goods shipped by sea.

Intermodalism, which means shifting the same container by different forms of transport, was the next logical step and today cargo is moved seamlessly by transferring a container between trucks, trains, and ships in order to achieve door-to-door delivery. It’s a complex process that is still being refined and J.B. Hunt is on the cutting edge.

Instead of meeting the railroads head on and competing for long distance haulage, the company has entered into partnership agreements with most of the leading rail carriers and complements each end of their operations in order to meet customer needs. Hunt has gone even further, contracting with hundreds of major corporations such as Home Depot to provide them with customized freight movement using systems and delivery services tailored to meet their particular requirements. In this connection, Hunt has 87 “last mile” support locations.

My point is that JBH is not a conventional trucking company. It is a dominant presence in intermodal and logistical services and well placed to benefit from the expected growth in railway earnings as the recovery gains traction. The numbers are already impressive. Class 1 railroads reported average earnings growth of 8% in first quarter 2014 in spite of severe weather. Residential construction and auto output tailwinds are spurring highway/rail shipments and a tighter trucking market is expected to push rates higher.

Hunt reported earnings of $0.58 a share in the first quarter, down slightly from $0.61 in the previous year due to the bad winter and unusual start-up costs in the Contract Services operations. However, management noted that customer demand was returning to normal late in the period and there was top line growth with intermodal load increasing 5% and truckload volumes up 9% year-over-year.

Looking ahead, significant investments by the railroads designed to broaden their intermodal markets should provide Hunt with scope to generate well above average volume growth. Earnings of about $3.15 a share are expected this year, compared to $2.87 in 2013, with a jump to the $4 range in 2015.

Action now: J.B. Hunt is a Buy with a target of $88. I have set $68 as a revisit level. The shares were trading on Thursday at $76.56.

TOM SLEE’S UPDATES

CN Rail (TSX: CNR, NYSE: CNI)

Originally recommended on May 6/02 (#2218) at C$12.98 (split-adjusted). Trading Thursday at C$63.70, US$58.55.

Shrugging off one of the worst winters on record, CN Railway turned in a respectable 2014 first quarter. Earnings of $0.66 a share were up 8.6% from an adjusted $0.61 in the same period of 2013 despite bad weather costing CN approximately $0.08 a share. The crucial operating ratio (the percentage of revenues needed to run the system) came in at 69.6%, still the best amongst Class 1 rails. There was solid volume growth and a free cash flow of $494 million during the period.

Perhaps most encouraging is the way CN is taking the difficult quarter in its stride. The company expects double-digit earnings growth in 2014 and a free cash flow in the $1.7 billion range. There is a record Canadian grain crop to support exports and the economic recovery is boosting intermodal traffic. Crude oil shipments are also trending higher. It all points to earnings of about $3.50 a share in 2014 and $4 or more next year.

CN Railway remains a cornerstone of our investment portfolio.

Action now: CN Rail is Buy with a target of $70. I will revisit the stock if it dips to $55.

Norfolk Southern (NYSE: NSC)

Originally recommended on Dec. 14/09 (#2944) at $52.22. Trading Thursday at $95.79. (All figures in U.S. currency.)

Norfolk Southern racked up earnings of $1.17 a share in the first quarter, slightly better than the $1.15 consensus forecast but down from $1.22 year-over-year due to lower coal shipments. Adverse weather was also a factor and cost the company about $50 million in revenues, although management estimates about $20 million of that was deferred and can be recaptured later in the year. The operating ratio declined slightly, less is better, to 75.2%. The company generated $207 million of free cash flow.

Looking ahead, Norfolk`s intermodal volumes are expected to surge in 2014 as traffic increases along its key corridors. Analysts expect a 10% increase in these shipments as new terminals at Greer, South Carolina and Charlotte, North Carolina come on stream. At the same time, conventional merchandise volumes should pick up as U.S. steel and automotive output increases.

As long as I can remember, Norfolk Southern has been regarded as a bulk carrier with its stock price largely governed by the price of lignite and soft coal. But that is changing. At the end of last year, merchandise shipments were accounting for 56% of the railroad’s revenues, while coal, a declining factor, contributed 22%. We should see this improving mix reflected in a higher earnings multiple for the stock.

Action now: Priced at $95.79, Norfolk Southern remains a Buy with a target of $110. I have set an $85 revisit level.

Finning International (TSX: FTT, OTC: FINGF)

Originally recommended on Aug. 31/09 (#2932) at C$16.61. Trading Thursday at C$30.04, US$28.12.

Finning International finished 2013 with a flourish. Earnings for the year came in at $1.95 a share versus $1.90 in 2012, with a free cash flow of $441 million. Revenues were a record $6.8 billion and the stock responded by trading close to $32. Since then, however, analysts have been concerned by reports that first quarter 2014 profits in Chile were far worse than expected. Management has released reassuring guidance but investors are nervous. Regardless of the initial numbers, foreign exchange is bound to be a headwind.

The shares, currently trading at $30.04, have performed well since our first recommendation at $16.61. Now, however, they appear to be fully priced and there is a question mark about the political and economic uncertainty in South America. I think it is time to take our profits.

Action now: Finning International is a Sell at $30.04. Including dividends of $2.39 a share we have a total return of 95%.

Stella Jones Inc. (TSX: SJ, OTC: STLJF)

Originally recommended on April 2/12 (#21213) at C$10.55 (split-adjusted). Trading Thursday at C$29.92, US$27.46.

Stella Jones traded at $32.74 in early April before pulling back to the current level. Still, we are up 184% from our original recommendation two years ago at a split-adjusted price of $10.55 and close to the $30 target. This is another company benefitting from the boom in railroads and I think the stock still has upside potential.

Action now: SJ remains a Buy with a new $37 target. I shall update the company in greater detail next time.

Alimentation Couche-Tard (TSX: ATD.B, OTC: ANCUF)

Originally recommended on March 4/13 (#21309) at C$17.62, US$17.13 (split-adjusted). Trading Thursday at C$29.60, US$27.35.

Alimentation’s stock split three for one in late April so you now own 300 shares for every 100 you had previously. At the current price of C$29.60, US$27.35, the stock is almost at my pre-split target of C$90 and continues to show strength. European margins are expected to jump this year and lift earnings. I will provide a full update soon but in the meantime I am raising my target to a post-split price of $37.

Action now: Buy.

– end Tom Slee


ZOMBIE BONDS

Like zombies, bonds refuse to stay dead.

Everyone, including me, thought the long fixed-income bull market came to an end last May. That’s when bond yields took a huge leap in the wake of comments by former Fed chairman Ben Bernanke about tapering the quantitative easing (QE) program. Bond prices sagged across the board (prices and yields have an inverse relationship). For the first time in many years, most bond funds and ETFs lost money in 2013, in some cases more than 3%.

More of the same was expected this year. As the global economy gained strength, interest rates were expected to start rising, always bad news for bonds. Combine that with the Fed’s tapering program, which is now being implemented, and you have the ingredients for a repeat of 2013, or worse.

It’s not working out that way. As I noted last week, the OECD is now expecting slower growth this year than originally anticipated. The new chair of the U.S. Federal Reserve Board, Janet Yellen, has indicated that interest rates will remain low into 2015 and perhaps beyond. The European economy looks fragile, with first-quarter growth in the 18 euro countries coming in at only 0.2%. That has led to speculation that the European Central Bank may cut rates and take other action to stimulate the moribund economy at its June 5 meeting.

Here at home, there’s talk that the next rate move by the Bank of Canada may be down instead of up. Until recently, it was almost an article of faith that the BoC would begin raising its target rate, currently at 1%, later this year or in 2015. That’s no longer the slam dunk it appeared to be.

Unlike the U.S., the BoC has some room to cut and some economists believe that unless the growth rate picks up, the Bank could drop its rate by 25 basis points in the fall. That would, at least in theory, give a boost to the economy while pushing down the value of the Canadian dollar. A lower loonie works to the advantage of exporters and the energy sector, among others, and there’s a growing view that the Bank would like to see our currency somewhere south of US$0.90.

The result of these changing attitudes has been a resurgence in the bond market. As of the close of trading on May 14, the DEX Universe Bond Index was showing a year-to-date gain of 4.13%. Both corporate and government issues have been doing well with government bonds up 4.09% while corporates are ahead 4.21%. Provincial bonds have been especially strong, gaining 5.22%.

What I find especially interesting is that long-term bonds have done exceptionally well, gaining 7.68% year-to-date. This suggests that bond traders believe that low rates will remain in place for some time to come.

Mutual funds and ETFs have reflected this bond market rebound. Almost all of the funds in the Canadian Fixed Income category are comfortably in profit territory so far in 2014, with a few showing gains of over 4% for the year. Among long bond funds, all but one are showing gains of 5%+ so far. The BMO Long Corporate Bond Index ETF (TSX: ZLC) leads the way with an advance for the year of 7.23%.

The zombie-like bond recovery reminds us yet again to take nothing for granted when it comes to investing. There are always surprises. A balanced portfolio is the best way to deal with them.

 

GORDON PAPE’S ETF UPDATES

iShares 1-5 Year Laddered Corporate Bond Index Fund (TSX: CBO)

Originally recommended on June 11/12 (#21220) at $20.24. Trading Thursday at $19.80.

This short-term bond ETF was recommended as a low-risk way to hold fixed-income securities and it continues to full that role very nicely. We’ve seen some erosion in the price but that has been more than compensated for by the monthly distributions we’ve received. These are currently running at about $0.07 per unit.

CBO showed an average annual compound rate of return of 3.1% over the two years to April 30. As of May 12, the year-to-date gain for 2014 was 1.7%, which is good for a fund of this type.

Action now: CBO is a Hold for conservative investors.

iShares Canadian Universe Bond Index ETF (TSX: XBB)

Originally recommended on March 5/07 (#2709) at $29.44. Trading Thursday at $30.89.

This bond ETF is down slightly from my last update in June 2013, at which time I advised reducing positions. However, it remains a decent fixed-income core holding because of its stability and steady cash flow – the current monthly payment is about $0.08 per unit.

The fund has changed its benchmark since the last review and now tracks the performance of the FTSE TMX Canada Universe Bond Index. This has resulted in a change in its name (previously it has tracked the DEX Universe Bond Index).

The fund had a weak year in 2013 losing 1.5% however it has recovered since and was showing a year-to-date gain for 2014 of almost 4%. That’s surprisingly strong and I doubt it can be maintained but it proves once again that there is always room for bonds in a portfolio.

Action now: Hold.

iShares BRIC Index Fund (TSX: CBQ)

Originally recommended on May 26/12 (#21212) at $27.36. Trading Thursday at $23.52.

It’s been a rough go for this fund. All four components have gone into the dumpster at the same time. Brazil’s economy has struggled, Russia has been hit by the escalating economic sanctions relating to its Ukraine policies, while China’s growth rate has slowed significantly and appears to have settled into a new, lower range. The one relatively bright spot has been India where the key index is up 12.8% year-to-date, largely on hopes that a new, pro-business government would be elected.

In short, the BRICs have lost their shine. As a result, these shares are down $3.84 from the original recommended price. We have received $1.28 in distributions, however, so our actual loss is 9.4%.

I dropped this fund from our TFSA Portfolio in March and now I suggest we also drop it from the Recommended List. Focus instead on the broader emerging markets or frontier markets.

Action now: Sell.

iShares MSCI Frontier 100 ETF (NYSE: FM)

Originally recommended on Feb. 10/14 (#21406) at $34.21. Trading Thursday at $37.98. (All figures in U.S. dollars.)

Speaking of frontier markets, we’ve had a nice run from our last review in March when I rated this fund as a Buy for aggressive investors at $34.93. Since then, we’ve seen a gain of $3.05 in the share price for an advance of 8.7%. We’re up 11% from the original recommendation in February.

However, there are some major changes coming. The fund is about to lose two of its biggest components, Qatar and the United Arab Emirates, which are being promoted to the MSCI Emerging Markets Index. They represent almost 38% of the ETF’s total assets, which means there is a huge hole that will have to be filled.

Russ Koesterich, chief investment strategist for BlackRock Capital, which owns the iShares franchise, tried to put a positive spin on this development in a recent note, saying: “My sense is that the new portfolio of companies in the index following the rebalancing will more accurately reflect what most people think of when they consider investing in frontier markets”.

That may be, but will they perform anywhere near as well? Investors in the fund will find they are holding larger positions in countries like Pakistan, Sri Lanka, and Vietnam. The sector mix will also change, with less exposure to financial stocks and more to consumer staples and energy.

The bottom line is that there is a lot of uncertainty about how the rebalancing will affect performance so my advice at this stage is not to add to positions until we get a better handle on the situation. Traders may wish to take their profits and exit now; otherwise maintain your position and watch.

Action now: Hold.

iShares Japan Fundamental Index Fund (TSX: CJP)

Originally recommended on April 29/13 (#21317) at $10.86. Trading Thursday at $10.78.

The bloom went off the Japanese rose very quickly. This ETF was trading in the $12 range at the beginning of the year but has since pulled back to close to our original recommended price as the Nikkei Index hit a soft spot, losing 11.5% year to date. A bounce back is always possible but my inclination is to exit this position in favour of better opportunities.

Action now: Sell.

iShares S&P 500 Index ETF (CAD-Hedged) (TSX: XSP)

Originally recommended on July 9/07 (#2725) at $19.22. Trading Thursday at $21.52.

New York’s S&P 500 Index has moved into record territory in recent weeks. That has given a big boost to this ETF, which had been bleeding red ink since the 2008-09 market crash. The one-year return of 21.6% (to April 30) looks good, but it was more than five percentage points below the average for the U.S. Equity category.

The reason for the relatively weak result is that this fund is hedged back into Canadian dollars. That works in favour of investors when the loonie is climbing against the U.S. greenback. But during periods when our dollar is in decline, hedging works against you.

Just over a year ago, BlackRock launched an unhedged stable mate to this fund, which trades under the symbol XUS. It has been the stronger performer so far this year, gaining 6.9% to May 13 compared to just 4.3% for the hedged version. The management fees for both funds were recently cut to a very attractive 0.1% so either is a good choice if you want exposure to U.S. large-cap stocks.

Many economists predict that the loonie will slide further over the coming year with some saying it could reach the US$0.80 range. I’m not that pessimistic but I think there is a strong possibility the loonie could slip to somewhere between US$0.85 and US$0.89 later this year. If you believe the Canadian dollar will fall, XUS is the better choice right now.

Action now: Hold. If you want exposure to potential gains in the U.S. dollar, switch to XUS.

iShares S&P/TSX Canadian Dividend Aristocrats Index Fund (TSX: CDZ)

Originally recommended on April 9/12 (#21214) at $22.29. Trading Thursday at $25.94.

This fund invests in Canadian stocks that have increased their dividends for at least five consecutive years and have a market cap of $300 million or more. You might think that would indicate a portfolio chock-full of large-cap stocks but you’d be wrong. Major holdings include AGF Management (5.4% of total assets), Exchange Income Corp. (3.5%), Enbridge Income Fund (2.9%), and Bird Construction (also 2.9%). The only true large-cap in the top 10 holdings is BCE Inc.

The fund pays monthly distributions, which started out at $0.06 per unit at the time of my recommendation and are now up to $0.06984. Since we first looked at this ETF we have received payments totaling $2.18. Combined with the capital gain, we have a total return of 26% in a little more than two years.

I continue to like this ETF but it’s important to understand exactly what you’re buying before you invest here. Take a look at the portfolio on the iShares website before making a decision.

Incidentally, this was not one of the iShares funds to benefit from the company’s recent price cuts. The management fee is 0.6% and the MER is 0.66%, which is on the high side for an ETF.

Action now: Buy.

YOUR QUESTIONS

TFSA profits

Q – I just read your book about TFSAs. My question is: If I am a middle or high income person, regardless my age, with a self directed account, able to get returns over 25% a year, saving for my retirement, what would be the best for me? Should I take advantage of the $5,500 allowance in my TFSA and the put the rest in my RRSP or invest everything in my RRSP and forget about putting any money in my TFSA?

My question is because in the book you are conservative about the returns and it is not clear for me what would be better between an RRSP or a TFSA if you can get higher returns. – Juan B.
 
A – If you can consistently produce returns of 25% a year, perhaps you would like to share your secrets with our readers. It’s something we’d all like to know. As far as your question is concerned, making use of the TFSA should certainly be your first priority. Any profits in an RRSP will be taxed at your marginal rate when the money comes out. Withdrawals from a TFSA are tax-free. – G.P.

 

HOUSEKEEPING

The following securities have been deleted from our on-line Recommended List. Sell advisories were issued some time ago so this notice is for record-keeping purposes only.

TEVA Pharmaceutical (NDQ: TEVA). Recommended by Glenn Rogers on July 19/10 at US$54.33. Sold May 13/13 at US$38.89.

Seagate Technology (NDQ: STX). Recommended by Glenn Rogers on April 23/12 at US$29.21. Sold May 13/13 at US$40.50.

Kirby Corp. (NYSE: KEX). Recommended by Glenn Rogers on July 11/11 at US$58.05. Sold Feb. 18/13 at US$75.03.

Fluor Corp. (NYSE: FLR). Recommended by Glenn Rogers on March 18/08 at US$68.27. Sold May 13/13 at US$61.91.

Dentsply International (NDQ: XRAY). Recommended by Glenn Rogers on Sept. 4/07 at US$39.38. Sold Oct. 22/12 at US$36.21.

 

That does it for this issue. The IWB will now go on hiatus for two weeks (we publish 44 times a year) while I take a much-needed vacation. Look for your next issue on June 9.

Best regards,

Gordon Pape