CanETF Portfolio June 2018 Update: More Emerging Markets Weakness

Market Highlights

Markets were primarily focused on the potential for a global trade war. Sky has a useful timeline of events.

In monetary policy news, the U.S. Federal Reserve hiked the overnight rate to a range of 1.75%-2.00% on June 13 and suggested two more hikes are coming in 2018.

Later in the month, Bank of Canada Governor Stephen Poloz talked up the odds of a rate hike in July.

Turning to oil, OPEC agreed on a modest increase in production in Vienna on June 22.

NameTickerJune 2018 Return2018 YTD Return
Canadian Listed ETFs
BMO S&P/TSX Capped Composite Index ETFZCN1.69%1.94%
BMO MSCI EAFE Index ETFZEA0.17%2.05%
BMO MSCI Emerging Markets Index ETFZEM-3.00%-2.90%
iShares Core Canadian Universe Bond Index ETFXBB0.57%0.56%
iShares Canadian Corporate Bond Index ETFXCB0.38%0.48%
Vanguard Canadian Short-Term Corporate Bond Index ETFVSC0.26%0.50%
iShares S&P/TSX Canadian Preferred Share Index ETFCPD0.28%0.50%
Vanguard FTSE Canadian Capped REIT Index ETFVRE2.31%5.14%
U.S. Listed ETFs
SPDR® S&P 500 ETFSPY0.60%2.59%
Vanguard FTSE Developed Markets ETFVEA-1.53%-2.71%
Vanguard FTSE Emerging Markets ETFVWO-4.49%-7.21%
iShares Core U.S. Aggregate Bond ETFAGG-0.13%-1.66%
iShares iBoxx $ Investment Grade Corporate Bond ETFLQD-0.72%-4.30%
Vanguard Short-Term Corporate Bond ETFVCSH-0.05%-0.53%
iShares iBoxx $ High Yield Corporate Bond ETFHYG0.38%0.14%
iShares U.S. Preferred Stock ETFPFF1.52%1.05%
Fidelity® MSCI Real Estate ETFFREL4.11%1.48%
USD/CAD1.70%4.97%

Emerging markets were particularly hard hit by the aforementioned trade war concerns and tightening monetary policy. The emerging markets ETFs in the table above have now experienced declines for five consecutive months after a strong advance in January.

REITs performed well in both Canada and the U.S., where the portfolio has exposure through the FREL holding. Canadian bonds and stocks did well, while in the U.S. fixed income was mixed and equities edged higher.

The effect of a strengthening U.S. dollar is apparent in the difference in returns between Canadian and U.S. listed ETFs investing in the same market. For example, developed markets in CAD and represented by ZEA were positive in the month, but negative in U.S. dollars as represented by VEA.

Monthly Portfolio Activity

June BalanceBeginning ValueEnding ValueChange ($)Change (%)
CAD TFSA
Cash$5,000.00$5,000.00$0.000.00%
USD RRSP
Cash$3,831.64$3,840.30$8.66
PFF$745.00$754.20$9.20
FREL$476.20$490.80$14.60
USD RRSP Total$5,052.84$5,085.30$32.460.64%
CAD Total$11,542.42$11,696.32$153.911.33%

Income was earned from both PFF (pays monthly) and FREL (pays quarterly).

Current Portfolio Allocation and Balance

 Current Value (In CAD)Current Allocation
CAD TFSA
Cash$5,000.0042.75%
USD RRSP
Cash$5,056.9143.24%
PFF$993.138.49%
FREL$646.295.53%
USD RRSP Total$6,696.3257.25%
Grand Total (CAD at $1.3168 per USD as of 6/29/2018)$11,696.32100.00%

Performance and Contribution

 SharesBeginning PriceEnding PriceIncomeReturn ($)Return (%)Contribution
PFF20$37.25$37.71$0.193889$13.081.76%0.11%
FREL20$23.81$24.54$0.239$19.384.07%0.17%

The CAD again weakened relative to the USD this past month, resulting in the USD RRSP balance being translated at a more favourable rate. Although both ETF holdings performed well, this currency translation provided the bulk of the increase of the Portfolio in Canadian dollar terms for June.

Trade Summary

No trades were placed in June.

Looking Ahead

Some reflection is in order now that the CanETF Portfolio is half a year old. Since inception, the Portfolio has gained $423.82 in CAD terms, or 3.76%. The USD exposure is responsible for the vast majority of this gain, but both ETF holdings contributed positively as detailed above. Two of six months had negative returns, the same two months in which the CAD strengthened relative the USD. This is an uncomfortable reminder of the dominant role of exchange rates as the driving factor of performance and not the ETF holdings themselves and reinforces the need to invest more of the cash balance.

That the CAD TFSA portion of the Portfolio remains fully uninvested is disappointing. The amount of unused USD in the RRSP portion of the Portfolio is high as well, but there is at least the potential for the USD to strengthen and deliver a gain in CAD terms. Because the home, or base, currency of the Portfolio is the CAD, holding USD is a sort of call in itself. However, the mandate of the strategy is to invest in ETFs to achieve the goal of positive absolute returns while avoiding losses and not to manage a basket of foreign currencies.

Hopefully there will be some activity on this front soon. A shopping list is prepared for several almost-attractively-priced asset classes with price targets that are within reach. Still, it is unlikely the Portfolio will get close to fully invested until a more severe market rout occurs, likely into the next global equity bear market.

One area of increasing interest is emerging market equities. While they remain above early 2016 lows, trailing P/E ratios for emerging markets have become much more appealing especially relative to developed markets. Because earnings growth is expected, the forward P/E is even lower.

TSX SPX MXEA MXEF Trailing P/E 06292018

Although it is unnerving to think of emerging markets as the sole equity exposure in the Portfolio from a risk perspective, further declines may warrant initiating a small allocation.

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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