CanETF Portfolio February 2018 Update: Volatility Returns

The second month for the CanETF Portfolio brought a second trade, the purchase of 20 shares of the  Fidelity® MSCI Real Estate Index ETF (FREL). Not only that, but a new milestone was reached when the Portfolio earned its first income, a distribution from the iShares U.S. Preferred Share ETF (PFF) holding purchased in January.

Market Highlights

Positive returns were scarce in February, as shown by the market representative ETFs below:

NameTickerFebruary 2018 Return2018 YTD Return
Canadian Listed ETFs
BMO S&P/TSX Capped Composite Index ETFZCN-3.00%-4.35%
BMO MSCI EAFE Index ETFZEA-0.82%2.04%
BMO MSCI Emerging Markets Index ETFZEM-1.26%4.83%
iShares Core Canadian Universe Bond Index ETFXBB0.14%-0.69%
iShares Canadian Corporate Bond Index ETFXCB-0.02%-0.32%
Vanguard Canadian Short-Term Corporate Bond Index ETFVSC0.18%0.11%
iShares S&P/TSX Canadian Preferred Share Index ETFCPD-1.09%0.50%
Vanguard FTSE Canadian Capped REIT Index ETFVRE-0.36%-1.64%
U.S. Listed ETFs
SPDR® S&P 500 ETFSPY-3.69%1.82%
Vanguard FTSE Developed Markets ETFVEA-5.24%-0.67%
Vanguard FTSE Emerging Markets ETFVWO-4.72%3.31%
iShares Core U.S. Aggregate Bond ETFAGG-0.97%-2.10%
iShares iBoxx $ Investment Grade Corporate Bond ETFLQD-2.07%-3.27%
Vanguard Short-Term Corporate Bond ETFVCSH-0.39%-0.82%
iShares iBoxx $ High Yield Corporate Bond ETFHYG-0.97%-0.55%
iShares U.S. Preferred Stock ETFPFF0.21%-1.13%
Fidelity® MSCI Real Estate ETFFREL-6.95%-9.47%
USD/CAD4.20%2.10%

Source: Morningstar.ca NAV returns for ETFs; Bank of Canada Daily Exchange Rates for currency

The big story in February was the return of volatility in markets, triggered by new worries over rising inflation. Reuters elaborates on the topic.  The chart below shows market inflation expectations are higher than they have been in several years. (The breakeven inflation rate is measured as the difference between the yield of a nominal bond and the inflation-linked bond of the same maturity.)

5 10 Year Breakeven Inflation Rate 02282018

Markets sold off sharply, with the Dow Jones Industrial Average dropping over 1,000 points on February 5th for the first time ever (an relatively easier feat now that the Dow is as high as it is; this was not nearly the largest single day percentage drop). The Chicago Tribute has a useful summary.

The U.S. equity market shortly afterwards reached an official correction (10% drop from the last peak) and although markets recovered some of the losses, it was not before a new tone was set. Perhaps the most memorable remnant of the sell-off, is the catastrophic loss of the short volatility trade, highlighted by the liquidation of the VelocityShares Daily Inverse VIX Short-Term ETN (XIV). Bloomberg details the carnage.

The Portfolio benefitted from not having equity exposure. Missing out on Canadian fixed income was a small negative as interest rates in Canada edged lower in the month. The sole holding going into the month, PFF, delivered a positive return thanks to the monthly distribution.

Monthly Portfolio Activity

February BalanceBeginning ValueEnding ValueChange ($)Change (%)
CAD TFSA
Cash$5,000.00$5,000.00$0.000.00%
USD RRSP
Cash$4,247.20$3,810.99($436.21)
PFF$752.40$750.60($1.80)
FREL$447.20$447.20
USD RRSP Total$4,999.60$5,008.79$9.190.18%
CAD Total$11,146.01$11,415.76$269.752.42%

While the timing of the PFF purchase in late January was a bit early, the timing on FREL buy turned out to be solid as the ETF only briefly traded in the low $22/high $21 area. Nevertheless, the loss on PFF narrowed such that both the Portfolio’s positions had a positive return in February.

Current Portfolio Allocation and Balance

 Current Value (In CAD)Current Allocation 
CAD TFSA
Cash$5,000.0043.80%
USD RRSP
Cash (USD translated to CAD)$4,881.5042.76%
PFF (USD translated to CAD)$961.448.42%
FREL (USD translated to CAD)$572.825.02%
USD RRSP Total in CAD$6,415.7656.20%
Grand Total (CAD at $1.2809 per USD as of 2/28/2018)$11,415.76100.00%

The strengthening U.S. dollar helped the portfolio to a gain overall, as the USD denominated RRSP balance is translated to CAD at a higher rate.

USDCAD 2018 YTD 02282018
Source: Bank of Canada

The overall portfolio value in CAD is now above the inception value after a decline in January.

Performance and Contribution

 SharesBeginning PriceEnding PriceIncomeReturn ($)Return (%)Contribution
PFF20$37.62$37.53$0.189298$1.990.26%0.02%
FREL20$22.00$22.36$0.00$7.201.64%0.06%

Trade Summary

DateTypeTickerSharesPriceCommissionTotalInto
2/8/2018BuyFREL20$22.00$0.00$440.00USD RRSP

After a weak end to 2017 and negative January, U.S. REITs sold off sharply amid the volatility in the markets. The Portfolio seized the opportunity and 20 shares of Fidelity® MSCI Real Estate ETF (FREL) were purchased.

Looking Ahead

Equity valuations have reset, as the falling prices have not been joined by falling earnings. Further selling pressure may bring stocks to an attractive level for beginning to build a position. Most major markets look better than the U.S. on a valuation basis, and Canada’s P/E ratio has compressed more than other markets.

TSX SPX MXEA MXEF Trailing P/E 02282018

Trailing P/E, local currency

Bonds are arguably more attractive in the U.S. because of the negative return in February, but the higher nominal yields come with increased inflation expectations. Higher real yields are still needed to entice capital to this space.

Canadian preferred shares are another area of interest. The rate reset feature that exists in most Canadian issues gives the asset class a unique characteristic that can counteract the negative effect on rising interest rates in other parts of the portfolio.

The CanETF Portfolio is not meant to be taken as investment advice. Please conduct due diligence on any ETF investment you are considering, including but not limited to a review of the prospectus, underlying benchmark methodology (if applicable), portfolio characteristics, holdings, performance since inception, role in your existing portfolio, and outlook for future performance.

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