TIPS, Spiders and WEBS can beat funds
HOW MUCH WILL YOU HAVE?
Saturday, May 8, 1999
The average Canadian equity fund got smoked last year by an obscure but easy-to-buy investment called TIPS 35.
It wasn't a fluke, either. TIPS 35 embarrassed the average equity fund over the past five years as well, and they did so while charging a fraction of what funds cost to own.
TIPS is short for Toronto 35 Index Participation Units, which pretty much describes what this investment is all about. When you own TIPS, you're able to participate in the performance of a stock index without owning shares.
There are index participation units available for the Dow Jones industrial average, the Standard & Poor's 500 index and for baskets of stocks in a variety of foreign markets. In Canada we have TIPS 35 (symbol: TIP) and TIPS 100 (HIP), which respectively reflect the Toronto Stock Exchange 35 index, home of some of the country's largest and most heavily traded stocks, and the TSE 100 index of large- and mid-capitalization stocks.
TIPS are a lot like mutual funds in that they afford an opportunity to play the market and benefit from diversification without the work of choosing individual stocks. There are a few important differences.
You buy TIPS like a stock, which means you have to pay commissions to buy and sell the units. But once you hold them, the management costs are microscopic when compared with mutual funds.
Both TIPS 35 and TIPS 100 have a management expense ratio of 0.05 per cent, a reflection of the fact that they're passive investments requiring no twiddling by a manager. For comparison's sake, the average large-cap Canadian equity fund has an MER of 2.26 per cent while domestic index funds range from 0.5 to 1.25 per cent. The accompanying chart shows this difference can mean a savings of thousands of dollars over a 10-year period.
Lower management costs also feed into the superior performance of TIPS, compared with funds. Imagine that an equity fund with a 2-per-cent MER and TIPS both earn a 10-per-cent gross return in a year. TIPS units would pay about 9.95 per cent after its management expenses are deducted, the mutual fund 8 per cent or so.
Now look at a real life example. Over the one-year period ended Dec. 31, 1998, the average large-cap domestic equity fund fell 2.9 per cent. The compound average annual return over five years is 8.4 per cent. TIPS 35 fell just 0.07 per cent in 1998 and rose 12.7 per cent over the five years. Newer TIPS 100 fell 0.37 per cent last year.
Aside from the lower management costs, the advantages of TIPS include a dividend yield in the area of 1.85 per cent for TIPS 35 and 1.7 per cent for TIPS 100.
There are also few capital gains distributions and thus a low exposure to taxes. Stocks are only sold to reflect changes in the index.
TIPS also offer good liquidity. They can be traded any time during market hours, while funds must be bought and sold at the day's closing net asset value per share.
There are a couple of drawbacks to TIPS as well, notably the fact that they can be as volatile as their underlying index. Skillful fund managers can cushion a market fall for their unitholders by keeping some assets in cash, for example.
Of course, good fund managers can beat the market as well, at least temporarily. You'll never beat the market with TIPS.
Another negative is that unlike funds, TIPS don't give you the option of having your dividends reinvested automatically. Some investment dealers may be able to set up a reinvestment plan, though.
Beyond TIPS, the menu of index participation units includes:
Diamonds: They trade on the American Stock Exchange under the symbol DIA and reflect the performance of the Dow Jones industrial average of 30 blue-chip stocks. The MER is 0.18 per cent, which compares with 2.21 per cent for the average U.S. equity fund.
SPDRs: An acronym for S&P depositary receipts. These participation units are known as Spiders and are traded on the Amex under the symbol SPY. They reflect the value of the S&P 500 index and charge an MER of about 0.18 per cent.
Sector SPDRs: They let you focus on nine industry areas, including technology and financials, consumer services, energy and utilities. MERs are 0.65 per cent.
Mid-cap SPDRs: Based on the S&P MidCap 400 index of mid-sized U.S. firms. The symbol is MDY, the MER 0.25 per cent.
WEBS: They offer a basket of stocks from 17 different countries. MERs range around 1.5 per cent.
One thing to be aware of is that TIPS will be discontinued in the not-too-distant future as part of the TSE's introduction of new indexes developed with Standard & Poor's Corp. of New York.
An announcement about how and when the move will be made is expected before the end of the year. A key question for investors is whether people holding TIPS will be cashed out, or allowed to take their existing units and transfer them into a replacement type of participation unit based on the S&P/TSE 60 index and possibly the S&P/TSE Canadian mid-cap index.
The Personal Finance column last Saturday talked about how management costs make mutual funds more expensive to own than stocks once your portfolio reaches a certain size.
If you don't have the time, knowledge or inclination to chuck your funds and start picking stocks, then TIPS and other participation units offer a nice compromise.
Comments and suggestions are welcomed at
The cost of having $10,000 invested for 10 years
Based on 10% before-fees annaul return. Cost is the sum of total fees, plus forgone earnings.
IPU What it What it
3% front- costs you costs you
& back-end after Mutual Median after
commission MER 10 years fund MER 10 years
TIPS 35 0.05% $1,204 equity 2.19% $5,152
TIPS 100 0.05% $1,204 equity 2.19% $5.152
SPDRs 0.18% $1,527 cap equity.2.3% $4,809
Mid-Cap SPDRs 0.30% $1,823 equity 2.5% $5,801
Technology science &
sector SPDRs 0.65% $2,666 technology.2.56% $5,925
Japan WEBS 1.19% $3,917 equity 2.46% $5,719
Diamonds 0.18% $1,527 cap equity.2.03% $4,809
Source: Investment Learning Centre. For mutual fund MER data - BellCharts Inc. at Dec. 31, 1998