In This Issue

RRSPS AND ETFS

By Gordon Pape, Editor and Publisher

A surprising number of people don’t realize that almost any type of security can be held in an RRSP, as long as you have the right type of plan. With interest rates continuing to bounce along near the bottom, we need to look beyond such traditional RRSP securities as GICs if we are going to generate reasonable returns over the next few years.

Last week, I described how an equity-based RRSP might be constructed to improve profit potential while minimizing risk. However, some people don’t like the idea of choosing individual stocks and prefer to use mutual funds or exchange-traded funds (ETFs) in their retirement plan. Today, I’ll discuss an ETF-based RRSP and I’ll conclude this series next week with some thoughts on using mutual funds.

ETFs have been around for decades but it is only in the past few years that they have received widespread investor acceptance in this country. Canadians have access to hundreds of them, although the great majority are U.S.-based. There are only four major companies offering Canadian-based ETFs: BlackRock (the iShares line-up), Claymore, BMO Financial Group, and BetaPro Management, of which Horizons AlphaPro is a subsidiary.

There are a lot of misconceptions about ETFs so let’s deal with those up-front.

They’re safer than mutual funds. This is simply not true. In fact, some are much riskier than any mutual fund you can find, such as the leveraged ETFs from BetaPro which can gyrate wildly in price from day to day. Leaving money in the wrong ETF for any length of time can wipe you out. For example, the Horizons BetaPro S&P/TSX Global Gold Bear+ ETF shows an average annual loss of 61.1% for the three years to Jan. 31. That means anyone foolish enough to have invested $1,000 three years ago and left the money there the entire time would have a grand total of $59 remaining!

It’s not just the leveraged ETFs that are risky. As a general rule, the narrower the focus of an equity-based ETF, the greater its potential volatility. Look at the Claymore Oil Sands Sector ETF as an example. In 2007, it gained 22.7%. The next year, it plunged 54.2%. In 2009, it bounced back with a 59% gain and followed that with a 15.3% advance in 2010. After all those gyrations, long-term investors were left with a three-year average annual compound rate of return of just 0.3% as of Jan. 31!

They are likely to generate higher returns than mutual funds. Every few months we read another article in the business pages telling us that the majority of active fund managers are not beating their benchmark indexes. Often, the main source for these stories is a press release from Standard & Poor’s, a company that happens to be in the index business and whose initials, S&P, are attached to numerous ETFs.

What people are not told is that ETFs rarely are able to beat their benchmarks and when it does happen it is something of a fluke. The reason is that once fees are deducted, even an ETF that closely tracks its benchmark will fall short of matching it. Look at the iShares S&P/TSX 60 Index ETF which has been around since 1999. Over the 10 years to Jan. 31, it generated an average annual compound rate of return of 5.79% while the benchmark S&P/TSX Total Return Index gained 6.21% a year. A Globefund search turned up 35 actively-managed Canadian equity funds that not only beat the iShares ETF but outperformed the index as well.

They’re cheaper than mutual funds. This is usually true if you consider only management expense ratios (MERs), which are the annual costs of operating a fund. Most ETFs have MERs of less than 0.5% and several are in the 0.2% to 0.3% range. But some of the newer, highly focused ETFs are more expensive. The relatively new Claymore Natural Gas Commodity ETF, which was launched in February 2008, has an MER of 0.92% while the Claymore China ETF has a management fee of 0.7%, with operating expenses on top of that.

Also, don’t lose sight of the fact that you must pay a brokerage commission when you buy and sell ETF units. That’s a cost that does not apply if you use no-load mutual funds or front-end load units at zero commission.

You can invest them and forget them. Yes you can, if you choose broadly-based funds with care and use a “couch potato” investing approach. But this will require a lot of patience and there will be frustrations along the way. We created a model couch potato ETF portfolio for the Mutual Funds/ETFs Update newsletter at the beginning of 2008. It consisted of a universe bond ETF (40%), a Canadian equity ETF (30%), a U.S. ETF (15%), and an international ETF (15%). No changes were made in the portfolio at any time; this was a real “invest-it-and-forget-it” approach. As of the last review, using returns to late November, it was showing a loss of 0.6% since it was created. I wonder how many people would have stuck with it for that long.

My feeling is that if you are going to build your RRSP using ETFs, you need to take an active approach. In theory, ETFs should be buy-and-hold securities but in the real world I think many people would lack the patience or the fortitude to stick with them, especially when stock markets are in free-fall.

Here’s what I suggest a well-designed balanced ETF-based RRSP might look like at the present time. I am assuming a value of approximately $50,000

200 iShares DEX Short Term Bond Index Fund (TSX: XSB). This short-term bond fund is a good defensive position during a period of rising interest rates and offers monthly cash flow of about $0.08 a unit as a bonus.

250 Claymore 1-5 Year Laddered Government Bond ETF (TSX: CLF). This is also a defensive position, focusing on short-term government bonds.

250 Claymore Advantaged High-Yield Bond ETF (TSX: CHB). This fund focuses on U.S. high-yield bonds with the returns hedged back into Canadian dollars. High-yield bonds are the most likely segment of the fixed-income market to advance this year.

175 iShares DEX Universe Bond Index (TSX: XBB). Normally this proven universe bond fund would be our core fixed-income position. However, in light of the current interest rate environment, it only has a weighting of about 10% right now. That should be increased once rates stabilize.

550 iShares S&P/TSX Capped Composite Index Fund (TSX: XIC). This ETF has been around for a decade and has acquitted itself well with an average annual compound rate of return since inception of 7.77%. The MER is a very low 0.25%.

150 Claymore International Fundamental Index ETF (TSX: CIE). This ETF tracks the performance of a basket of the 1,000 largest companies that are not listed in the U.S. It has been through a tough period (three-year average annual return of -3.68%) but is doing much better now. The MER is 0.68%.

75 Claymore Broad Emerging Markets ETF (TSX: CWO). This relatively new fund, launched in mid 2009, gives us exposure to high-growth emerging markets by investing its assets in units of the Vanguard Emerging Markets ETF (NYSE: VWO). If you don’t want the currency hedging that the Claymore fund provides, you can buy VWO directly and reduce your MER from 0.7% to 0.27%.

25 iShares Morningstar Small Core Index Fund (NYSE: JKJ). The only Canadian-based ETF that tracks the U.S. small-cap market is the iShares Russell 2000 Index Fund CAD-Hedged ETF (TSX: XSU). If you want the currency hedging feature you can use it but you’ll pay a slightly higher MER (0.35% compared to 0.27% for the U.S. version of the same fund). If you’re willing to forego the hedging, I recommend the Morningstar Small Core ETF instead. It has a solid track record (five-year average annual compound rate of return of 5.34%) and low MER (0.25%).

Remember, this is only a sample portfolio. It is designed it to be well-diversified by both market cap and geography and to offer reasonable growth potential with an acceptable level of risk.

As with the equity-based portfolio that I described last week, I will not be tracking this going forward.

 

Follow Gordon Pape’s latest updates on Twitter: http://twitter.com/GPUpdates

GLENN ROGERS LOOKS ACROSS THE PACIFIC

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Contributing editor Glenn Rogers is with us this week, writing from his home in California which overlooks the Pacific Ocean. It seems he’s been spending some time staring out the window and thinking about what’s going on thousands of miles away in China and he has come up with some interesting investment ideas to share with us. Glenn is a successful businessman and entrepreneur who has lived and worked in both Canada and the U.S. Here is his report.

Glenn Rogers writes:

I’ve hope you have enjoyed the market ride during the last few months as much as I have. Pretty much everything is up as the stock market has shrugged off all kinds of normally disturbing news: Revolutions in Egypt and Tunisia, soaring food prices, looming political deadlock in Washington over spending cuts, and more.

Despite all the turmoil, so far nothing has been able to keep this market down for long. The only problem – and it’s a big one – is that it’s getting harder to find stocks that are cheap enough so that you don’t feel you are chasing a train that left the station a while ago. Valuations look a little stretched so, like everyone else it seems, I’ve been waiting for some kind of pullback that would enable me to add to positions that have been performing well. So far, that hasn’t happened. Don’t get me wrong. I’m not longing for another market crash, only a modest correction that would restore a sense of balance and provide new opportunities to deploy cash.

While I’m waiting, I’ve been looking at areas that haven’t been doing particularly well. That led me to emerging markets which for the most part have been selling off. In some cases the drop has been fairly dramatic; for example the Indian NSE 50 Index is down more than 10% so far in 2011 and I’m not sure that the selling is over yet. Looking elsewhere, the FTSA China 25 Index is off about 15% from its highs of late last year but given the inflation scares in the emerging markets and the interest rate hikes in China it could have been much worse. Brazil, another fast-growing BRIC country, has also pulled back although not as much as either China or India.

All this started me thinking about which stocks and which sectors are relatively inflation-proof while offering exposure to emerging market growth, particularly in China. I kept coming back to a basket of Chinese Internet stocks which, with a few exceptions, have not significantly pulled back with the rest of the Chinese market.

There are a lot of things to like about the Internet in China where they had a total of 384 million web surfers at the end of 2009. That is greater than the entire population of the United States and that’s with a penetration of only 23% so there is lots of room to grow. Overall usage is increasing at close to 30% a year with the Internet population growing at what likely is a conservative rate of 20% per year.

The Internet market in China is young; close to 70% of all web surfers are under the age of 30. That’s why gaming sites like Shanda Games Ltd. (NDQ: GAME), which was spun off last year from Shanda Interactive Entertainment (NDQ: SNDA) looks interesting even though it has not performed well to date and is not my principal recommendation in this column.

There are number of ways to get exposure to Chinese Internet stocks and a site that I like called tickerspy.com has created an index which you might find helpful in researching these opportunities. It can be found here: http://tiny.cc/si8dx

As I scanned down that list, two stocks kept jumping out at me. The first was Baidu Inc. (NDQ: BIDU), which can be found at www.baidu.com. The website is in Chinese but Google will translate it for you. The second was Youku.com Inc. (NDQ: YOKU) which is at www.youku.com. These companies are the Google and YouTube of China respectively. Let me tell you a little more about them.

Baidu has been in the news a lot in the last year as they were seen to benefit from Google’s decision to essentially withdraw from mainland China. Given their recent stellar results, they do seem to be profiting nicely. Recent fourth-quarter earnings were stellar, with revenue rising 94% and earnings soaring 171%. Baidu now has over 70% of the Chinese search market. If you like Google here in North America you have to love Baidu in China even though its forward p/e ratio is twice that of Google. Baidu’s quarterly sales growth is close to four times that of Google and they have no real competition.

After the stock split last year I bought a position when it was trading in the $60s and sold when it reached $112. I have regretted that sell decision ever since and have been hoping for a pullback so I could reenter. Well, I’m finished waiting! I plan to take a position now and continue to add to it over time because I feel this is a long-term hold and the stock may well continue to move up a lot further over the next couple of years.

Youku.com is a different story. It fell by almost 50% after its IPO late last year but as I write it is rallying on heavy volume prior to its earnings call which is scheduled for Feb. 28. As I’m sure most of you know, Google purchased YouTube some time ago and it appears that deal is beginning to pay off for them. It has taken a while for video advertising to grow on the web, lagging behind the heavy traffic that video users have presented to the advertising community globally which is a phenomenon I can personally attest to as I own a large video site myself: www.streetfire.net. However, we are now seeing the advertising community begin to embrace online video sites which will be as good for Youku.com as it is for YouTube.

Imitation is the sincerest form of flattery and it is not a stretch to believe that both these companies may one day equal or surpass the success of the sites that they have copied. They have the Chinese government in their corner, offering a barrier to entry to sites originating from other countries. They also have a growing youth market and a strong economy. That’s a pretty great combination of factors which should lead to continued exponential growth.

Both companies trade on Nasdaq as American Depository Receipts (ADRs).

Action now: Buy Baidu with a target of US$180. The stock closed on Friday at US$128.80. Buy Youko.com at US$34.50 with a target of US$50.

 

GLENN ROGERS’S UPDATES

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Walgreens (NYSE: WAG)

Originally recommended on July 20/09 (IWB #2927) at $29.82. Closed Friday at $42.74 (all figures in U.S. currency).

I recommended America’s largest drugstore chain back in July 2009 when it was trading at $29.82. I reiterated my buy rating in December of that year when the stock was trading at $38.81. On Friday it closed at $42.74 for overall gain of 46% based on my original recommendation, including dividends totaling $0.90.

Walgreens had a pretty good month in January with sales increasing by 0.5% but that’s down from sales in December and only modestly up from a dismal year ago in January 2010.

I think it’s time to ring the register and take profits here. I’m not a big fan of retailers in general otherwise I would likely put a hold rating on the stock but we have had a nice gain and I think the upside is somewhat limited. The stock is trading near its 52-week high and I think there are better places to put your money. I don’t hate the stock; I just think it’s time to move on.

Action now: Sell for a gain of 46.3%.

Agrium Inc. (TSX, NYSE: AGU)

Originally recommended on April 30/07 (IWB #2717) at C$46.41, US$41.40. Closed Friday at C$92.01, US$93.28.

Agrium was trading on Toronto at C$46.41 and on the NYSE at US$41.40 at the time I recommended the stock in April 2007. After it rose 66%, I suggested taking half profits in September 2010. Since then the stock has continued to skyrocket along with the rest of the fertilizer companies and in fact along with all the rest of the agriculture-based issues. The shares closed Friday at C$92.01, US$93.28 for a total gain of 98.3% in Canadian dollars and 125.3% in U.S. currency.

As readers of my recent columns know, I’m still a big fan of the agricultural trade and I would continue to hold a position in this stock. If you didn’t take half profits the last time I suggested it, I would urge you to do so now. There is nothing fundamentally wrong with this company but after a massive gain like this it is prudent to take something off the table. I’m hoping we will get a meaningful pullback in this stock and in Potash Corp. (TSX, NYSE: POT) so I can increase my position but right now the valuations are starting to get a little stretched. Don’t get greedy: take some profits.

Action now: Take part profits if you have not already done so, otherwise Hold.

iShares S&P Global Technology Sector Index Fund (NYSE: IXN )

Originally recommended on Nov. 5/07 (IWB #2740) at $69.59. Closed Friday at $66.07 (all figures in U.S. currency).

This basket of global technology stocks includes such names as Apple Inc., Microsoft, IBM, Google, Oracle, Intel, etc. It has done well along with the rest of the tech sector in recent months, rising 22% last year. I suggested this ETF as a good way to play global technology and it has certainly done better than had you simply bought shares in Microsoft or Cisco (but not as well as if you had purchased Apple).

I see this as a good core holding for people who prefer to invest through ETFs. Keep your positions and add to them on any meaningful pullback.

Action now: Hold.

Textainer Group Holdings (NYSE: TGH)

Originally recommended on Nov. 23/09 (IWB #2942) at $15.68. Closed Friday at $35.54 (all figures in U.S. currency).

Textainer, which is based in Bermuda, is the largest shipping container leasing company in the world. It operates globally offices in South America, Europe, the Mediterranean region, the Middle East, Asia, and Africa. The big Singapore office handles Southeast Asia, China, and Australia.

This stock has been a huge winner for us since I recommended it in November 2009 when it was trading at $15.68. I suggested taking half profits last August when it already risen 75% and was trading at the time at $27.52. The company has continued to perform well, closing Friday at $35.54 for a gain of 126.7% since the original recommendation.

On Feb. 10, Textainer released fourth-quarter and year-end results (to Dec. 31) and they were impressive. Net income attributable to common shareholders for the quarter was $40 million ($0.81 a share), which was an increase of $14.7 million, or 58%, compared to $25.3 million for the same period in 2009. For fiscal 2010, the company earned $120 million ($2.43 per share), up 32% from 2009.

The company announced it is passing on some of the profits to shareholders with a dividend increase of 7.4% to $0.29 per quarter ($1.16 a year). The yield going forward based on the current price is 3.3% but readers who bought shares at the time of my original recommendation will enjoy a 7.4% dividend return this year.

Even at current valuations the stock doesn’t look too expensive with a trailing p/e ratio of 14.4. As the global economy continues to improve, demand for this company’s services should rise along with it so I continue to hold it in my portfolio.

Action now: Hold.

– end Glenn Rogers

 

BETTER DAYS AHEAD FOR THE U.S.

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We returned to our winter home in Florida a few weeks ago and one of the first things that struck me was how truly unhappy and even desperate many Americans are. The good news is there are indications that the worst may be over.

Most Canadians don’t fully comprehend just how bad things have been in the States. We were fortunate enough to escape the worst ravages of the recession and our real estate market held firm even through the worst of the world financial crisis. Of course, we’ve all seen the news reports about the gravity of the U.S. situation but until you actually come here and talk to people you can’t fully appreciate the depths of despair.

South-west Florida, where we stay, was one of the hardest-hit areas and in some ways is a microcosm of America’s woes. Lee County, which includes the cities of Fort Myers and Cape Coral, enjoyed an incredible but highly speculative building boom during the early years of this century as developers carved out huge gated communities from cheap scrub land and sold them off at increasingly absurd prices.

It was a classic bubble situation and when the recession hit it broke not with a pop but with an explosion. Lee County has been near the top of the national list of the highest rates of foreclosures for the past two years. In January alone, another 851 families lost their homes. The situation has become so bad that the county has an official website where people can go to bid on foreclosed properties that are being auctioned off. It makes for pathetic reading: homes that were once worth more than $350,000 have seen their assessed value plunge to less than $75,000 in some cases. The eventual selling price may be less than that.

Unemployment hovered around the 13% mark for most of 2010. To put that in perspective, Lee County had one of the lowest unemployment levels in the U.S. as recently as 2005-2006, when the jobless figure was in the 2%-3% range. To make matters even more difficult for those seeking work, a bill has been introduced in the Florida legislature that would require the state’s unemployed people to perform at least four hours of unpaid community service each week to qualify for benefits. The idea is to reduce the spiraling cost of Florida’s unemployment benefits system which is currently running a $2 billion deficit.

Given these numbers, it should come as no surprise that a recent poll found that one in five Floridians is seriously considering leaving the state. You can’t eat sunshine!

However, there are signs that things are starting to get better, both locally and nationally. The headline in last Thursday’s local paper read: “Glut of new homes is whittled”. The article went on to say that the huge surplus of unsold houses left over from the building boom that ended in 2006 has been cut almost in half from its peak in late 2009. This inventory has depressed real estate prices throughout the region; once it is cleared the markets can start returning to normal.

Nationally, credit agency TransUnion reported a small drop in the percentage of homeowners that are behind in their mortgage payments by more than 60 days. Investors have regained confidence in the stock market, with the major U.S. indexes off to their best start in several years. Industry leader Delta Airlines increased its fares for business class and first class, an indication that demand for high-end travel is picking up. The manufacturing index of the Federal Reserve Bank of Philadelphia almost doubled from January to February. Inflation has replaced deflation as the main concern for policy makers, with the U.S. consumer price index rising by a greater-the-expected 0.4% in January.

The minutes of the January meeting of the Federal Reserve Board’s Open Market Committee (FOMC), which were released last week, confirm that the recovery is in place and gaining traction. Studies by staff members found that consumer spending rose strongly in the final months of 2010, industrial production posted solid increases in November and December, and business investment in equipment and software was on the rise.

“Because the incoming data on production and spending were stronger, on balance, than the staff’s expectations at the time of the December FOMC meeting, the near-term forecast for the increase in real GDP was revised up,” the minutes said. The expectation now is that the U.S. economy will grow by between 3.4% and 3.9% this year while the unemployment forecast was revised down slightly.

There are three important implications for investors in all this, as follows.

1. The window of opportunity is closing for Canadians who want to take advantage of what may be a once-in-a-lifetime confluence of low interest rates, a strong loonie, and depressed U.S. housing prices to buy a vacation property. We now appear to close to the bottom of the market and, if current trends continue, U.S. home prices may gradually start to rise later this year.

2. A great deal of cash has been sitting on the sidelines waiting for signs of improvement in the U.S. economy. That money is flowing back into equities, pushing indexes higher. As Glenn Rogers points out in his column this week, it is getting hard to find bargains any more but that is not likely to stop the flood of new cash. This reinforces my view that U.S. markets will outperform the TSX this year. If you haven’t already benefitted, it’s not too late but don’t delay any longer.

3. The TSX will feed off positive momentum in the U.S. market even though the make-up of our Composite Index is far different than that of the Dow or the S&P 500 given our top-heavy weightings in resources and financials.

So let’s hope that the positive signs we are seeing in the U.S. are true indicators that the long-awaited recovery has begun – both for the sake of our investments and because it would mean an easing of the financial pressures that so many Americans are experiencing. – G.P.

 

GORDON PAPE’S UPDATES

TransCanada Inc. (TSX, NYSE: TRP)

Originally recommended by Yola Edwards on April 24/06 (IWB #2616) at C$34.07, US$29.92. Closed Friday at C$38.01, US$38.54.

On Feb. 15, TransCanada reported fourth-quarter earnings per share of $0.39, down from $0.56 a share in the same period of 2009. Despite this, the pipeline company announced a 5% dividend increase to $0.42 per share quarterly ($1.68 per year). It’s the 11th year in a row that the company has hiked its payout. Based on Friday’s closing price, new investors will receive a yield of 4.4% this year.

The drop in net income reflects the impact of a $127 million after-tax, one-time valuation provision recorded against the Mackenzie Gas Project. For the full fiscal year, net income per share totaled $1.78, down 16% from 2009.

In another development, the company boosted the estimated cost of its contentious KeyStone XL pipeline by US$1 billion to US$13 billion, citing regulatory delays as part of the reason. The project, which has been waiting for approval from the U.S. State Department, is opposed by environmental groups and by some powerful American Congressional leaders. A decision is not expected until late this year as a result.

Action now: Hold.

 

MEMBERS’ CORNER

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Discount brokers

Member comment: In response to the subscriber who indicated he had a Scotia McLeod online trading account (IWB #21105), I have both an online RRSP trading account as well as a TFSA trading account with them plus my two daughters recently set up TFSA trading accounts. So unless SM has now discontinued the TFSA trading option the subscriber has been given erroneous information! – Ted D.

Member comment: I’m afraid you were off the mark when you said that investors should not expect to get in-house research from discount brokers. I have accounts with both RBC Direct and TD Waterhouse. In both cases, I have instant access (via the Internet) to their in-house research reports. They also provide investment advice from other sources, most notably, research on individual stocks and investment advice from S&P.
 
So, I get the best of both worlds: low commissions and all the research that I want! It is actually easier to access the research since I don’t have to go through a local investment rep and wait for them to forward it to me! – Dan H.
 
Response: Actually, I did not say that discount brokers don’t provide access to research – only that it is not on the same level as is generally available from full-service brokers, based on my experience. I’d be interested in receiving comments on this from members who have accounts with both types of brokers. – G.P.

 

That’s all for this week. We’ll be back on Feb. 28.

Best regards,

Gordon Pape
gordon.pape@buildingwealth.ca
Circulation matters: customer.service@buildingwealth.ca

All material in the Internet Wealth Builder is copyright Gordon Pape Enterprises Ltd. and may not be reproduced in whole or in part in any form without written consent. None of the content in this newsletter is intended to be, nor should be interpreted as, an invitation to buy or sell securities. All recommendations are based on information that is believed to be reliable. However, results are not guaranteed and the publishers, contributors, and distributors of the Internet Wealth Builder assume no liability whatsoever for any material losses that may occur. Readers are advised to consult a professional financial advisor before making any investment decisions. The staff of and contributors to the Internet Wealth Builder may hold positions in securities mentioned in this newsletter, either personally or through managed accounts. No compensation for recommending particular securities, services, or financial advisors is solicited or accepted.

In This Issue

RRSPS AND ETFS

By Gordon Pape, Editor and Publisher

A surprising number of people don’t realize that almost any type of security can be held in an RRSP, as long as you have the right type of plan. With interest rates continuing to bounce along near the bottom, we need to look beyond such traditional RRSP securities as GICs if we are going to generate reasonable returns over the next few years.

Last week, I described how an equity-based RRSP might be constructed to improve profit potential while minimizing risk. However, some people don’t like the idea of choosing individual stocks and prefer to use mutual funds or exchange-traded funds (ETFs) in their retirement plan. Today, I’ll discuss an ETF-based RRSP and I’ll conclude this series next week with some thoughts on using mutual funds.

ETFs have been around for decades but it is only in the past few years that they have received widespread investor acceptance in this country. Canadians have access to hundreds of them, although the great majority are U.S.-based. There are only four major companies offering Canadian-based ETFs: BlackRock (the iShares line-up), Claymore, BMO Financial Group, and BetaPro Management, of which Horizons AlphaPro is a subsidiary.

There are a lot of misconceptions about ETFs so let’s deal with those up-front.

They’re safer than mutual funds. This is simply not true. In fact, some are much riskier than any mutual fund you can find, such as the leveraged ETFs from BetaPro which can gyrate wildly in price from day to day. Leaving money in the wrong ETF for any length of time can wipe you out. For example, the Horizons BetaPro S&P/TSX Global Gold Bear+ ETF shows an average annual loss of 61.1% for the three years to Jan. 31. That means anyone foolish enough to have invested $1,000 three years ago and left the money there the entire time would have a grand total of $59 remaining!

It’s not just the leveraged ETFs that are risky. As a general rule, the narrower the focus of an equity-based ETF, the greater its potential volatility. Look at the Claymore Oil Sands Sector ETF as an example. In 2007, it gained 22.7%. The next year, it plunged 54.2%. In 2009, it bounced back with a 59% gain and followed that with a 15.3% advance in 2010. After all those gyrations, long-term investors were left with a three-year average annual compound rate of return of just 0.3% as of Jan. 31!

They are likely to generate higher returns than mutual funds. Every few months we read another article in the business pages telling us that the majority of active fund managers are not beating their benchmark indexes. Often, the main source for these stories is a press release from Standard & Poor’s, a company that happens to be in the index business and whose initials, S&P, are attached to numerous ETFs.

What people are not told is that ETFs rarely are able to beat their benchmarks and when it does happen it is something of a fluke. The reason is that once fees are deducted, even an ETF that closely tracks its benchmark will fall short of matching it. Look at the iShares S&P/TSX 60 Index ETF which has been around since 1999. Over the 10 years to Jan. 31, it generated an average annual compound rate of return of 5.79% while the benchmark S&P/TSX Total Return Index gained 6.21% a year. A Globefund search turned up 35 actively-managed Canadian equity funds that not only beat the iShares ETF but outperformed the index as well.

They’re cheaper than mutual funds. This is usually true if you consider only management expense ratios (MERs), which are the annual costs of operating a fund. Most ETFs have MERs of less than 0.5% and several are in the 0.2% to 0.3% range. But some of the newer, highly focused ETFs are more expensive. The relatively new Claymore Natural Gas Commodity ETF, which was launched in February 2008, has an MER of 0.92% while the Claymore China ETF has a management fee of 0.7%, with operating expenses on top of that.

Also, don’t lose sight of the fact that you must pay a brokerage commission when you buy and sell ETF units. That’s a cost that does not apply if you use no-load mutual funds or front-end load units at zero commission.

You can invest them and forget them. Yes you can, if you choose broadly-based funds with care and use a “couch potato” investing approach. But this will require a lot of patience and there will be frustrations along the way. We created a model couch potato ETF portfolio for the Mutual Funds/ETFs Update newsletter at the beginning of 2008. It consisted of a universe bond ETF (40%), a Canadian equity ETF (30%), a U.S. ETF (15%), and an international ETF (15%). No changes were made in the portfolio at any time; this was a real “invest-it-and-forget-it” approach. As of the last review, using returns to late November, it was showing a loss of 0.6% since it was created. I wonder how many people would have stuck with it for that long.

My feeling is that if you are going to build your RRSP using ETFs, you need to take an active approach. In theory, ETFs should be buy-and-hold securities but in the real world I think many people would lack the patience or the fortitude to stick with them, especially when stock markets are in free-fall.

Here’s what I suggest a well-designed balanced ETF-based RRSP might look like at the present time. I am assuming a value of approximately $50,000

200 iShares DEX Short Term Bond Index Fund (TSX: XSB). This short-term bond fund is a good defensive position during a period of rising interest rates and offers monthly cash flow of about $0.08 a unit as a bonus.

250 Claymore 1-5 Year Laddered Government Bond ETF (TSX: CLF). This is also a defensive position, focusing on short-term government bonds.

250 Claymore Advantaged High-Yield Bond ETF (TSX: CHB). This fund focuses on U.S. high-yield bonds with the returns hedged back into Canadian dollars. High-yield bonds are the most likely segment of the fixed-income market to advance this year.

175 iShares DEX Universe Bond Index (TSX: XBB). Normally this proven universe bond fund would be our core fixed-income position. However, in light of the current interest rate environment, it only has a weighting of about 10% right now. That should be increased once rates stabilize.

550 iShares S&P/TSX Capped Composite Index Fund (TSX: XIC). This ETF has been around for a decade and has acquitted itself well with an average annual compound rate of return since inception of 7.77%. The MER is a very low 0.25%.

150 Claymore International Fundamental Index ETF (TSX: CIE). This ETF tracks the performance of a basket of the 1,000 largest companies that are not listed in the U.S. It has been through a tough period (three-year average annual return of -3.68%) but is doing much better now. The MER is 0.68%.

75 Claymore Broad Emerging Markets ETF (TSX: CWO). This relatively new fund, launched in mid 2009, gives us exposure to high-growth emerging markets by investing its assets in units of the Vanguard Emerging Markets ETF (NYSE: VWO). If you don’t want the currency hedging that the Claymore fund provides, you can buy VWO directly and reduce your MER from 0.7% to 0.27%.

25 iShares Morningstar Small Core Index Fund (NYSE: JKJ). The only Canadian-based ETF that tracks the U.S. small-cap market is the iShares Russell 2000 Index Fund CAD-Hedged ETF (TSX: XSU). If you want the currency hedging feature you can use it but you’ll pay a slightly higher MER (0.35% compared to 0.27% for the U.S. version of the same fund). If you’re willing to forego the hedging, I recommend the Morningstar Small Core ETF instead. It has a solid track record (five-year average annual compound rate of return of 5.34%) and low MER (0.25%).

Remember, this is only a sample portfolio. It is designed it to be well-diversified by both market cap and geography and to offer reasonable growth potential with an acceptable level of risk.

As with the equity-based portfolio that I described last week, I will not be tracking this going forward.

 

Follow Gordon Pape’s latest updates on Twitter: http://twitter.com/GPUpdates

GLENN ROGERS LOOKS ACROSS THE PACIFIC

Contributing editor Glenn Rogers is with us this week, writing from his home in California which overlooks the Pacific Ocean. It seems he’s been spending some time staring out the window and thinking about what’s going on thousands of miles away in China and he has come up with some interesting investment ideas to share with us. Glenn is a successful businessman and entrepreneur who has lived and worked in both Canada and the U.S. Here is his report.

Glenn Rogers writes:

I’ve hope you have enjoyed the market ride during the last few months as much as I have. Pretty much everything is up as the stock market has shrugged off all kinds of normally disturbing news: Revolutions in Egypt and Tunisia, soaring food prices, looming political deadlock in Washington over spending cuts, and more.

Despite all the turmoil, so far nothing has been able to keep this market down for long. The only problem – and it’s a big one – is that it’s getting harder to find stocks that are cheap enough so that you don’t feel you are chasing a train that left the station a while ago. Valuations look a little stretched so, like everyone else it seems, I’ve been waiting for some kind of pullback that would enable me to add to positions that have been performing well. So far, that hasn’t happened. Don’t get me wrong. I’m not longing for another market crash, only a modest correction that would restore a sense of balance and provide new opportunities to deploy cash.

While I’m waiting, I’ve been looking at areas that haven’t been doing particularly well. That led me to emerging markets which for the most part have been selling off. In some cases the drop has been fairly dramatic; for example the Indian NSE 50 Index is down more than 10% so far in 2011 and I’m not sure that the selling is over yet. Looking elsewhere, the FTSA China 25 Index is off about 15% from its highs of late last year but given the inflation scares in the emerging markets and the interest rate hikes in China it could have been much worse. Brazil, another fast-growing BRIC country, has also pulled back although not as much as either China or India.

All this started me thinking about which stocks and which sectors are relatively inflation-proof while offering exposure to emerging market growth, particularly in China. I kept coming back to a basket of Chinese Internet stocks which, with a few exceptions, have not significantly pulled back with the rest of the Chinese market.

There are a lot of things to like about the Internet in China where they had a total of 384 million web surfers at the end of 2009. That is greater than the entire population of the United States and that’s with a penetration of only 23% so there is lots of room to grow. Overall usage is increasing at close to 30% a year with the Internet population growing at what likely is a conservative rate of 20% per year.

The Internet market in China is young; close to 70% of all web surfers are under the age of 30. That’s why gaming sites like Shanda Games Ltd. (NDQ: GAME), which was spun off last year from Shanda Interactive Entertainment (NDQ: SNDA) looks interesting even though it has not performed well to date and is not my principal recommendation in this column.

There are number of ways to get exposure to Chinese Internet stocks and a site that I like called tickerspy.com has created an index which you might find helpful in researching these opportunities. It can be found here: http://tiny.cc/si8dx

As I scanned down that list, two stocks kept jumping out at me. The first was Baidu Inc. (NDQ: BIDU), which can be found at www.baidu.com. The website is in Chinese but Google will translate it for you. The second was Youku.com Inc. (NDQ: YOKU) which is at www.youku.com. These companies are the Google and YouTube of China respectively. Let me tell you a little more about them.

Baidu has been in the news a lot in the last year as they were seen to benefit from Google’s decision to essentially withdraw from mainland China. Given their recent stellar results, they do seem to be profiting nicely. Recent fourth-quarter earnings were stellar, with revenue rising 94% and earnings soaring 171%. Baidu now has over 70% of the Chinese search market. If you like Google here in North America you have to love Baidu in China even though its forward p/e ratio is twice that of Google. Baidu’s quarterly sales growth is close to four times that of Google and they have no real competition.

After the stock split last year I bought a position when it was trading in the $60s and sold when it reached $112. I have regretted that sell decision ever since and have been hoping for a pullback so I could reenter. Well, I’m finished waiting! I plan to take a position now and continue to add to it over time because I feel this is a long-term hold and the stock may well continue to move up a lot further over the next couple of years.

Youku.com is a different story. It fell by almost 50% after its IPO late last year but as I write it is rallying on heavy volume prior to its earnings call which is scheduled for Feb. 28. As I’m sure most of you know, Google purchased YouTube some time ago and it appears that deal is beginning to pay off for them. It has taken a while for video advertising to grow on the web, lagging behind the heavy traffic that video users have presented to the advertising community globally which is a phenomenon I can personally attest to as I own a large video site myself: www.streetfire.net. However, we are now seeing the advertising community begin to embrace online video sites which will be as good for Youku.com as it is for YouTube.

Imitation is the sincerest form of flattery and it is not a stretch to believe that both these companies may one day equal or surpass the success of the sites that they have copied. They have the Chinese government in their corner, offering a barrier to entry to sites originating from other countries. They also have a growing youth market and a strong economy. That’s a pretty great combination of factors which should lead to continued exponential growth.

Both companies trade on Nasdaq as American Depository Receipts (ADRs).

Action now: Buy Baidu with a target of US$180. The stock closed on Friday at US$128.80. Buy Youko.com at US$34.50 with a target of US$50.

 

GLENN ROGERS’S UPDATES

Walgreens (NYSE: WAG)

Originally recommended on July 20/09 (IWB #2927) at $29.82. Closed Friday at $42.74 (all figures in U.S. currency).

I recommended America’s largest drugstore chain back in July 2009 when it was trading at $29.82. I reiterated my buy rating in December of that year when the stock was trading at $38.81. On Friday it closed at $42.74 for overall gain of 46% based on my original recommendation, including dividends totaling $0.90.

Walgreens had a pretty good month in January with sales increasing by 0.5% but that’s down from sales in December and only modestly up from a dismal year ago in January 2010.

I think it’s time to ring the register and take profits here. I’m not a big fan of retailers in general otherwise I would likely put a hold rating on the stock but we have had a nice gain and I think the upside is somewhat limited. The stock is trading near its 52-week high and I think there are better places to put your money. I don’t hate the stock; I just think it’s time to move on.

Action now: Sell for a gain of 46.3%.

Agrium Inc. (TSX, NYSE: AGU)

Originally recommended on April 30/07 (IWB #2717) at C$46.41, US$41.40. Closed Friday at C$92.01, US$93.28.

Agrium was trading on Toronto at C$46.41 and on the NYSE at US$41.40 at the time I recommended the stock in April 2007. After it rose 66%, I suggested taking half profits in September 2010. Since then the stock has continued to skyrocket along with the rest of the fertilizer companies and in fact along with all the rest of the agriculture-based issues. The shares closed Friday at C$92.01, US$93.28 for a total gain of 98.3% in Canadian dollars and 125.3% in U.S. currency.

As readers of my recent columns know, I’m still a big fan of the agricultural trade and I would continue to hold a position in this stock. If you didn’t take half profits the last time I suggested it, I would urge you to do so now. There is nothing fundamentally wrong with this company but after a massive gain like this it is prudent to take something off the table. I’m hoping we will get a meaningful pullback in this stock and in Potash Corp. (TSX, NYSE: POT) so I can increase my position but right now the valuations are starting to get a little stretched. Don’t get greedy: take some profits.

Action now: Take part profits if you have not already done so, otherwise Hold.

iShares S&P Global Technology Sector Index Fund (NYSE: IXN )

Originally recommended on Nov. 5/07 (IWB #2740) at $69.59. Closed Friday at $66.07 (all figures in U.S. currency).

This basket of global technology stocks includes such names as Apple Inc., Microsoft, IBM, Google, Oracle, Intel, etc. It has done well along with the rest of the tech sector in recent months, rising 22% last year. I suggested this ETF as a good way to play global technology and it has certainly done better than had you simply bought shares in Microsoft or Cisco (but not as well as if you had purchased Apple).

I see this as a good core holding for people who prefer to invest through ETFs. Keep your positions and add to them on any meaningful pullback.

Action now: Hold.

Textainer Group Holdings (NYSE: TGH)

Originally recommended on Nov. 23/09 (IWB #2942) at $15.68. Closed Friday at $35.54 (all figures in U.S. currency).

Textainer, which is based in Bermuda, is the largest shipping container leasing company in the world. It operates globally offices in South America, Europe, the Mediterranean region, the Middle East, Asia, and Africa. The big Singapore office handles Southeast Asia, China, and Australia.

This stock has been a huge winner for us since I recommended it in November 2009 when it was trading at $15.68. I suggested taking half profits last August when it already risen 75% and was trading at the time at $27.52. The company has continued to perform well, closing Friday at $35.54 for a gain of 126.7% since the original recommendation.

On Feb. 10, Textainer released fourth-quarter and year-end results (to Dec. 31) and they were impressive. Net income attributable to common shareholders for the quarter was $40 million ($0.81 a share), which was an increase of $14.7 million, or 58%, compared to $25.3 million for the same period in 2009. For fiscal 2010, the company earned $120 million ($2.43 per share), up 32% from 2009.

The company announced it is passing on some of the profits to shareholders with a dividend increase of 7.4% to $0.29 per quarter ($1.16 a year). The yield going forward based on the current price is 3.3% but readers who bought shares at the time of my original recommendation will enjoy a 7.4% dividend return this year.

Even at current valuations the stock doesn’t look too expensive with a trailing p/e ratio of 14.4. As the global economy continues to improve, demand for this company’s services should rise along with it so I continue to hold it in my portfolio.

Action now: Hold.

– end Glenn Rogers

 

BETTER DAYS AHEAD FOR THE U.S.

We returned to our winter home in Florida a few weeks ago and one of the first things that struck me was how truly unhappy and even desperate many Americans are. The good news is there are indications that the worst may be over.

Most Canadians don’t fully comprehend just how bad things have been in the States. We were fortunate enough to escape the worst ravages of the recession and our real estate market held firm even through the worst of the world financial crisis. Of course, we’ve all seen the news reports about the gravity of the U.S. situation but until you actually come here and talk to people you can’t fully appreciate the depths of despair.

South-west Florida, where we stay, was one of the hardest-hit areas and in some ways is a microcosm of America’s woes. Lee County, which includes the cities of Fort Myers and Cape Coral, enjoyed an incredible but highly speculative building boom during the early years of this century as developers carved out huge gated communities from cheap scrub land and sold them off at increasingly absurd prices.

It was a classic bubble situation and when the recession hit it broke not with a pop but with an explosion. Lee County has been near the top of the national list of the highest rates of foreclosures for the past two years. In January alone, another 851 families lost their homes. The situation has become so bad that the county has an official website where people can go to bid on foreclosed properties that are being auctioned off. It makes for pathetic reading: homes that were once worth more than $350,000 have seen their assessed value plunge to less than $75,000 in some cases. The eventual selling price may be less than that.

Unemployment hovered around the 13% mark for most of 2010. To put that in perspective, Lee County had one of the lowest unemployment levels in the U.S. as recently as 2005-2006, when the jobless figure was in the 2%-3% range. To make matters even more difficult for those seeking work, a bill has been introduced in the Florida legislature that would require the state’s unemployed people to perform at least four hours of unpaid community service each week to qualify for benefits. The idea is to reduce the spiraling cost of Florida’s unemployment benefits system which is currently running a $2 billion deficit.

Given these numbers, it should come as no surprise that a recent poll found that one in five Floridians is seriously considering leaving the state. You can’t eat sunshine!

However, there are signs that things are starting to get better, both locally and nationally. The headline in last Thursday’s local paper read: “Glut of new homes is whittled”. The article went on to say that the huge surplus of unsold houses left over from the building boom that ended in 2006 has been cut almost in half from its peak in late 2009. This inventory has depressed real estate prices throughout the region; once it is cleared the markets can start returning to normal.

Nationally, credit agency TransUnion reported a small drop in the percentage of homeowners that are behind in their mortgage payments by more than 60 days. Investors have regained confidence in the stock market, with the major U.S. indexes off to their best start in several years. Industry leader Delta Airlines increased its fares for business class and first class, an indication that demand for high-end travel is picking up. The manufacturing index of the Federal Reserve Bank of Philadelphia almost doubled from January to February. Inflation has replaced deflation as the main concern for policy makers, with the U.S. consumer price index rising by a greater-the-expected 0.4% in January.

The minutes of the January meeting of the Federal Reserve Board’s Open Market Committee (FOMC), which were released last week, confirm that the recovery is in place and gaining traction. Studies by staff members found that consumer spending rose strongly in the final months of 2010, industrial production posted solid increases in November and December, and business investment in equipment and software was on the rise.

“Because the incoming data on production and spending were stronger, on balance, than the staff’s expectations at the time of the December FOMC meeting, the near-term forecast for the increase in real GDP was revised up,” the minutes said. The expectation now is that the U.S. economy will grow by between 3.4% and 3.9% this year while the unemployment forecast was revised down slightly.

There are three important implications for investors in all this, as follows.

1. The window of opportunity is closing for Canadians who want to take advantage of what may be a once-in-a-lifetime confluence of low interest rates, a strong loonie, and depressed U.S. housing prices to buy a vacation property. We now appear to close to the bottom of the market and, if current trends continue, U.S. home prices may gradually start to rise later this year.

2. A great deal of cash has been sitting on the sidelines waiting for signs of improvement in the U.S. economy. That money is flowing back into equities, pushing indexes higher. As Glenn Rogers points out in his column this week, it is getting hard to find bargains any more but that is not likely to stop the flood of new cash. This reinforces my view that U.S. markets will outperform the TSX this year. If you haven’t already benefitted, it’s not too late but don’t delay any longer.

3. The TSX will feed off positive momentum in the U.S. market even though the make-up of our Composite Index is far different than that of the Dow or the S&P 500 given our top-heavy weightings in resources and financials.

So let’s hope that the positive signs we are seeing in the U.S. are true indicators that the long-awaited recovery has begun – both for the sake of our investments and because it would mean an easing of the financial pressures that so many Americans are experiencing. – G.P.

 

GORDON PAPE’S UPDATES

TransCanada Inc. (TSX, NYSE: TRP)

Originally recommended by Yola Edwards on April 24/06 (IWB #2616) at C$34.07, US$29.92. Closed Friday at C$38.01, US$38.54.

On Feb. 15, TransCanada reported fourth-quarter earnings per share of $0.39, down from $0.56 a share in the same period of 2009. Despite this, the pipeline company announced a 5% dividend increase to $0.42 per share quarterly ($1.68 per year). It’s the 11th year in a row that the company has hiked its payout. Based on Friday’s closing price, new investors will receive a yield of 4.4% this year.

The drop in net income reflects the impact of a $127 million after-tax, one-time valuation provision recorded against the Mackenzie Gas Project. For the full fiscal year, net income per share totaled $1.78, down 16% from 2009.

In another development, the company boosted the estimated cost of its contentious KeyStone XL pipeline by US$1 billion to US$13 billion, citing regulatory delays as part of the reason. The project, which has been waiting for approval from the U.S. State Department, is opposed by environmental groups and by some powerful American Congressional leaders. A decision is not expected until late this year as a result.

Action now: Hold.

 

MEMBERS’ CORNER

Discount brokers

Member comment: In response to the subscriber who indicated he had a Scotia McLeod online trading account (IWB #21105), I have both an online RRSP trading account as well as a TFSA trading account with them plus my two daughters recently set up TFSA trading accounts. So unless SM has now discontinued the TFSA trading option the subscriber has been given erroneous information! – Ted D.

Member comment: I’m afraid you were off the mark when you said that investors should not expect to get in-house research from discount brokers. I have accounts with both RBC Direct and TD Waterhouse. In both cases, I have instant access (via the Internet) to their in-house research reports. They also provide investment advice from other sources, most notably, research on individual stocks and investment advice from S&P.
 
So, I get the best of both worlds: low commissions and all the research that I want! It is actually easier to access the research since I don’t have to go through a local investment rep and wait for them to forward it to me! – Dan H.
 
Response: Actually, I did not say that discount brokers don’t provide access to research – only that it is not on the same level as is generally available from full-service brokers, based on my experience. I’d be interested in receiving comments on this from members who have accounts with both types of brokers. – G.P.

 

That’s all for this week. We’ll be back on Feb. 28.

Best regards,

Gordon Pape
gordon.pape@buildingwealth.ca
Circulation matters: customer.service@buildingwealth.ca

All material in the Internet Wealth Builder is copyright Gordon Pape Enterprises Ltd. and may not be reproduced in whole or in part in any form without written consent. None of the content in this newsletter is intended to be, nor should be interpreted as, an invitation to buy or sell securities. All recommendations are based on information that is believed to be reliable. However, results are not guaranteed and the publishers, contributors, and distributors of the Internet Wealth Builder assume no liability whatsoever for any material losses that may occur. Readers are advised to consult a professional financial advisor before making any investment decisions. The staff of and contributors to the Internet Wealth Builder may hold positions in securities mentioned in this newsletter, either personally or through managed accounts. No compensation for recommending particular securities, services, or financial advisors is solicited or accepted.