ETFs: Telling it like it is

Say what you like about exchange-traded funds (ETFs). If nothing else, they tell it like it is. You don’t have to read between the lines to figure out what is happening in world markets.

Most of these funds (but not all) are the ultimate in transparency. That’s because there is nowhere to hide. The managers of these funds are required to track the performance of their benchmarks as closely as possible. They can’t build cash reserves or shift their emphasis to more defensive securities in tough times such as these. If their benchmark index tanks, so do the funds. It’s that simple.

So it should come as no surprise that most ETFs that track a stock-related index are coming off a terrible year. But the losses vary considerably depending on the mandate of the particular fund.

There are two major players in the conventional ETF market in Canada: iShares (run by Barclays Global Investors Canada) and the funds offered by Claymore Investments Inc. Horizons BetaPro also has a series of ETFs but they are all leveraged plays on specific indexes or sectors with bull and bear options. Here’s a look at the best and worst performers from all three groups over the year to Jan. 31.

Claymore Investments Inc. Of the 17 Claymore funds with a track record of at least one year, only one made a profit. It was the Claymore 1-5 Year Laddered Government Bond ETF (TSX: CLF) which invests in short-term securities issued or guaranteed by the federal and provincial governments. It posted a gain of 7.2 per cent over the 12 months to Jan. 31. That was unusually high for a fund of this type and I don’t expect anything close to a repeat performance in 2009 with interest rates so low.

Among Claymore’s equity-based ETFs, the best performer was the Claymore S&P/TSX CDN Preferred Share ETF (TSX: CPD) which dropped 14.4 per cent over the year. It tracks the movements of the Canadian preferred share market and I expect to see better results from this one in the rest of 2009.

While no one likes to lose 14 per cent at any time, that result looks very good when you compare it to the performance of the Claymore BRIC ETF (TSX: CBQ) which invests in Brazil, Russia, India, and China. It fell a stunning 55.3 per cent over the year and is still on a downward slope. If you’re in it, you may want to run for cover at this point.

Barclays Global Investors Canada. Barclays offers several bond-based iShares ETFs but it may come as something of a surprise to learn that not all of them were profitable over the 12 months we’re studying. The best result came from the iShares CDN Government Bond Index Fund (TSX: XGB) which posted a gain of 6.5 per cent. That was less than the Claymore 1-5 Year Government Bond ETF but the iShares fund tracks the DEX All-Government Bond Index which includes medium and long-term bonds as well. So the two cannot be directly compared.

Long bonds did not fare as well as short-term bonds in the past year. The iShares CDN Long Term Bond Index Fund (TSX: XLB) was ahead only 0.84 per cent while the iShares CDN Real Return Bond Fund (TSX: XRB) fell 2.4 per cent as worries about inflation all but vanished. The iShares CDN Bond Index Fund (TSX: XBB) and the iShares CDN Short Bond Index Fund (TSX: XSB) gained 4.5 per cent and 6.1 per cent respectively.

All of the iShares equity funds were hit hard. Best of the bunch was the iShares CDN Gold Sector Index Fund (TSX: XGD) which showed a 12-month loss of 11.7 per cent to Jan. 31. But the only reason that decline was so small was the big resurgence in bullion prices recently. Over the three months to the end of January, the fund surged 64.5 per cent as gold briefly topped US$1,000 an ounce. The momentum slowed dramatically in February, however.

The worst performer was the iShares CDN S&P 500 Index Fund (TSX: XSP), which was down 41.8 per cent for the year to Jan. 31. The loss was exacerbated by the fact the fund is hedged back into Canadian dollars; the U.S. version of the same fund fared slightly better, giving back 38.6 per cent which almost precisely matched the index performance.

Horizons BetaPro. The leveraged HBP funds have either done wonderfully or miserably depending on whether you bet on the markets going up or down. Investors who put their money on a rebound suffered big losses with the worst being the 92.3 per cent plunge in the value of the HBP NYMEX Crude Oil Bull + ETF (TSX: HOU). As you might guess, the bear version of the fund, which trades under the symbol HOD, was the top performer over the 12 months, gaining 171.2 per cent. The six-month figure, which covers the period when oil prices plummeted, was an astounding +520.4 per cent.

Interestingly, in some cases in didn’t matter whether you chose the bear play or the bull play. Both lost money. The HBP S&P/TSX Global Gold Bear ETF (TSX: HGD) fell 80.7 per cent over the year to Jan. 31. So the bull version (TSX: HGU) must have been a big winner, right? Well, no – it lost 58.1 per cent for the year despite a 120 per cent rebound in the latest three months.

This is why I have never recommended any of the HBP funds – they are too volatile and unpredictable for my liking and they lack the transparency that makes index funds so attractive.

Gordon Pape ‘s new book is Tax-Free Savings Accounts: A Guide to TFSAs and How They Can Make You Rich. Buy your copy at 27 per cent off the suggested retail price at