Indexing Strategies For Your RRSP/RRIF

IPUs may be your best choice.

Index funds and index participation units (IPUs) have seized the attention of many RRSP and RRIF investors recently for two reasons. First, many actively-managed Canadian equity funds failed to match (or even come close to) the 1999 performance of the TSE 300. Second, index funds are cheap. Many are no-load and most have very low management fees.

Index products are what are known as “passive” investments. They simply track the performance of whatever index they are based on. If it rises, they follow suit. If it falls, ditto.

By contrast, most actively-managed mutual funds seek to outperform the indexes through superior stock selection. A few take a safety-first approach, with the goal of protecting investors’ capital in the event of a major crash – which of course would pull down the value of any index-linked product except one with a guarantee of principal, like a GIC.

There is no doubt that a good, actively-managed fund will outperform a benchmark index at times. The trick is to find funds that will do it consistently. Unfortunately, there are not many. In calendar 1999, for example, most Canadian stock funds that use a value sle stunk out the joint. The TSE 300 clobbered them. Ivy Canadian, the largest Canadian Equity Fund, gained just 3.1%. By contrast, funds using growth and/or momentum styles soared. AIM Canadian Premier Fund jumped 61%. Universal Future gained 48.7%. Altamira Equity was ahead 47.8%. Synergy Canadian Momentum Fund was up 42.9%. There are lots of others that beat the TSE 300 as well. But if you didn’t have at least one of them in your RRSP or RRIF portfolio, your Canadian equity holdings did very poorly

For this reason, I’ve come around to the view that it’s a good strategy to use index products to form the core of your equity holdings. You can then add actively-managed funds that suit your investment personality and your goals.

Index mutual funds are increasingly popular, but in fact the most efficient index products are the IPUs. The problem with index funds is that even the cheapest of them carry much higher management fees than you’ll pay by investing in an IPU. Even if the fund tracks the performance of the index perfectly, your return will be deflated by the amount of the annual management cost.

It’s true that the majority of index funds are no-load, with many coming from the big banks. If you purchase IPUs, you’ll have to pay a brokerage commission. But if you’re going to use indexing as a long-term portfolio strategy, the initial cost of the commission will work out to a lot less over time than paying a much higher annual management charge.

For the Canadian stock market, I recommend the use of the new i60 units (TSE: XIU), which track the S&P/TSE 60 Index. The units represent a basket of stocks in the index. They collect dividends on the holdings, which are paid quarterly.

If you want to track U.S. indexes in the same way, there are a number of products available. The best known is SPDRs (Standard &Poor’s Depository Receipts), which track the S&P 500 Index (Nasdaq: SPY). There is also a mid-cap version of SPDRs (Nasdaq: MDY). Other choices include DIAMONDS (ASE: DIA), which track the Dow and Nasdaq-100 shares (Nasdaq: QQQ). Best for RRSP/RRIF purposes are SPDRs, however they are classified as foreign content so are governed by the 25% rule. If that’s a problem, there are several no-load, fully-RRSP eligible index funds that track the S&P 500, such as the CIBC U.S. Equity Index RRSP Fund.

Using IPUs to track international markets is more difficult. WEBS (Morgan Stanley World Equity Benchmark Shares) are the most popular way to do this, but there are 17 series available, each of which tracks the performance of a specific market (e.g. Hong Kong, U.K., France, Japan). This puts the onus on the investor or the advisor to decide on the appropriate country weightings, which is no simple task. As well, WEBS will eat into your foreign content room. For those reasons, I recommend going the mutual fund route if you want to add an international index component to your RRSP or RRIF. There are several no-load possibilities that did well in 1999, including Altamira International RSP Index Fund, Green Line International RSP Index Fund, and Royal International RSP Index Fund.

What percentage of your RRSP portfolio should be devoted to index products? There is no simple answer; it depends on how aggressive you want the equity section of your plan to be. But one suggested formula is to put 50% of your equity assets into index products and the other half into actively managed funds.

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