Since their introduction, the Vanguard and iShares asset allocation ETFs have dramatically transformed the landscape for investors, amassing billions in assets under management. These funds have rapidly become favorites within the DIY investing community, thanks to their ability to provide investors with access to a globally diversified portfolio of stocks and bonds at costs far below those of traditionally managed mutual funds.
Why Choose These ETFs? The appeal of these ETFs lies not only in their affordability but also in their simplicity and effectiveness. With just a few clicks, Canadian investors can own a slice of global markets, avoiding the high fees typically associated with active fund management.
Understanding Your Investment Before you commit to investing, it’s crucial to delve into the specifics of what you’re buying. This series will uncover the essential components of these popular portfolios, providing a clear view of their structures and strategic nuances.
Focus on VCN and XIC In this discussion, we spotlight two standout broad-market Canadian equity ETFs:
- Vanguard FTSE Canada All Cap Index ETF (VCN): Launched in 2013, VCN offers comprehensive coverage across all market caps in the Canadian equity landscape.
- iShares Core S&P/TSX Capped Composite Index ETF (XIC): With a track record starting in 2001, XIC focuses on the major sectors of the Canadian market, implementing a cap to ensure no single company dominates the fund.
Cost Efficiency Both ETFs boast exceptionally low management expense ratios (MERs), making them highly cost-effective. To put it into perspective, the annual cost of managing a $10,000 investment in either ETF is comparable to the price of a specialty Starbucks latte—demonstrating their affordability.
Reliability and Popularity Thanks to their low fees and solid performance history, these ETFs have not only attracted significant investment but also offer stability—making it unlikely that they would be discontinued anytime soon.
By choosing VCN or XIC, investors can secure a reliable and economical foothold in Canadian markets. As we proceed, we’ll explore the specific indexes these ETFs track, their performance histories, and how they fit into a well-rounded investment portfolio.
Fund Construction and Index Tracking: A Comparative Look at VCN and XIC
When selecting an equity ETF, understanding the underlying index and construction methodology is crucial. Both VCN and XIC offer distinct approaches to capturing the Canadian market, though their practical differences might be subtle for the general investor.
Index Tracking Differences
- iShares Core S&P/TSX Capped Composite Index ETF (XIC): XIC adheres to the S&P/TSX Capped Composite Index, which aims to represent about 95% of the Canadian equities market, spanning large, mid, and small-cap stocks. Crucially, this “Capped” structure ensures that no single company’s weight exceeds 10% of the total index to maintain a balanced exposure. This capping mechanism is a safeguard against the dominance of any one company, reminiscent of the early 2000s when Nortel Networks constituted more than a third of the uncapped S&P/TSX Composite Index, posing significant concentration risk.
- Vanguard FTSE Canada All Cap Index ETF (VCN): In contrast, VCN is based on the FTSE Canada All Cap Domestic Index, which includes companies across all capitalizations without imposing any upper limit on individual company weights. This “All Cap” approach allows for a true reflection of market movements, including the significant growth of top performers that can exceed 10% of the index, offering potentially greater rewards at the risk of higher volatility.
Fund Construction Nuances The construction of each ETF is driven by market-capitalization weighting, a method where the market value of a company’s outstanding shares determines its weight in the index. This process involves:
- Valuation of the Broad Market: Index providers calculate the total market capitalization by summing up the values of all eligible stocks in the market.
- Determination of Individual Weights: Each company’s market capitalization is then divided by the total index value to assign its weight in the index.
Operational Execution: Following this methodology, an ETF like VCN or XIC purchases shares in proportions that mirror these calculated weights, aiming to replicate the index performance accurately. For investors, this means their holdings in these ETFs are reflective of the broader market dynamics, with larger companies typically exerting more influence over the index performance.
Practical Implications for Investors While both ETFs are designed to offer broad market exposure, their different indexing strategies might appeal to different investor preferences:
- Risk and Diversification: Investors concerned with over-exposure to any single stock might prefer XIC’s capped approach, which limits any company’s dominance in the portfolio.
- Market Representation: Those seeking an unfettered representation of the market might lean towards VCN’s all-cap strategy, accepting the additional risk for a potentially higher reward.
In essence, whether you choose VCN or XIC should align with your investment philosophy and risk tolerance. Both ETFs are structured to provide effective market coverage, but their slight variations cater to different strategic preferences.
Analysis of Top Index Holdings in Canadian Equity ETFs
The table below details the major holdings within the Canadian equity ETFs, VCN and XIC, highlighting the dominance of large-cap companies in the Canadian stock market. These companies are pivotal, not just within their respective sectors but also in terms of their impact on the national economy and the ETFs’ performance.
| Company | Ticker | Float Adjusted Market Cap (CAD Billions) | Index Weight |
|---|---|---|---|
| Royal Bank of Canada | RY | $176.3 | 6.9% |
| Toronto-Dominion Bank | TD | $154.1 | 6.0% |
| Enbridge Inc. | ENB | $103.8 | 4.1% |
| Canadian National Railway Co. | CNR | $87.7 | 3.4% |
| Canadian Pacific Railway Ltd. | CP | $85.7 | 3.3% |
| Bank of Montreal | BMO | $81.3 | 3.2% |
| Brookfield Asset Management Inc. | BAM.A | $79.6 | 3.1% |
| Bank of Nova Scotia | BNS | $78.6 | 3.1% |
| Canadian Natural Resources Ltd. | CNQ | $74.2 | 2.9% |
| Nutrien Ltd. | NTR | $63.5 | 2.5% |
| Other Canadian Companies | – | $1,577.4 | 61.6% |
| Total Index | – | $2,562.2 | 100.0% |
Sources: MSCI Canada IMI index fact sheet as of September 30, 2022
Implications of Market-Cap Weighting
The market-capitalization weighting used in these indexes means that the largest companies hold disproportionate influence over the index’s movements. This structure leads to a scenario where:
- Dominant Sectors: Financials and energy, sectors that traditionally have large-cap companies in Canada, significantly influence the ETFs’ performance. This is reflected in the substantial weights of banks and energy companies in the index.
- Impact on Diversification: The heavy concentration in a few large companies and sectors can pose a risk of reduced diversification. While this may offer stability during times of strong sector performance, it also exposes investors to potential downturns concentrated in these industries.
- Investment Strategy Considerations: Investors should be mindful of this concentration when building a diversified portfolio. Incorporating ETFs or assets from different sectors or global markets can help mitigate this risk, providing a more balanced investment approach.
This analysis underscores the need for investors to consider not only the individual merits of each ETF but also how they fit into a broader, diversified investment strategy, especially given the concentrated nature of the Canadian market.
Analysis of Top ETF Holdings and Their Impact on Performance
The allocation of investments in major Canadian ETFs such as VCN and XIC demonstrates a significant emphasis on large-cap companies, primarily from the financial and energy sectors. The following table summarizes the top holdings and their respective weights within these ETFs:
| Company | Ticker | VCN Weight | XIC Weight |
|---|---|---|---|
| Royal Bank of Canada | RY | 6.8% | 6.5% |
| Toronto-Dominion Bank | TD | 6.0% | 5.7% |
| Enbridge Inc. | ENB | 4.1% | 3.9% |
| Canadian National Railway Co. | CNR | 3.6% | 3.4% |
| Canadian Pacific Railway Ltd. | CP | 3.3% | 3.2% |
| Bank of Montreal | BMO | 3.2% | 3.0% |
| Brookfield Asset Management Inc. | BAM.A | 2.9% | 3.0% |
| Bank of Nova Scotia | BNS | 3.1% | 2.9% |
| Canadian Natural Resources Ltd. | CNQ | 2.8% | 2.7% |
| Nutrien Ltd. | NTR | 2.4% | 2.3% |
| Total | – | 38.3% | 36.6% |
Sources: BlackRock Asset Management Canada Limited, Vanguard Investments Canada Inc., as of September 30, 2022
Differences and Similarities in Fund Composition
While both VCN and XIC track similar market indices, their slight variances in weight allocations reflect minor differences in their respective index-tracking methodologies. These differences, however, are generally subtle and do not typically translate into significant performance discrepancies over the long term.
- Sector Concentration: The heavy weighting towards financial and energy stocks in both ETFs is indicative of the broader Canadian market’s composition. This concentration can influence the ETFs’ performance, especially in response to sector-specific economic shifts.
- Impact of Large Caps on Performance: As the table illustrates, the performance of these ETFs is heavily influenced by their largest holdings. The substantial collective weight of the top ten holdings underscores their pivotal role in the performance of each fund, reflecting the market-cap weighted strategy employed by both ETFs.
Investment Implications
For investors, the concentration of investments in these top companies means that the health of the Canadian financial and energy sectors can have a disproportionate impact on the overall performance of these ETFs. This highlights the importance of considering sector diversification when investing in broad-market Canadian equity ETFs:
- Understanding Risk: Investors should be aware of the inherent risks associated with the concentration in a few large-cap stocks and sectors. While this provides opportunities for significant gains during good times, it also poses risks during economic downturns.
- Diversification Strategies: To mitigate these risks, investors might consider diversifying their portfolios beyond these ETFs by incorporating funds that focus on other sectors or international markets.
This analysis provides a clear understanding of how top holdings in VCN and XIC impact fund performance and offers strategic insights for investors looking to balance risk and return in their investment portfolios.
Allocation Breakdown by Company Size in VCN and XIC ETFs
To understand the distribution of investments within VCN and XIC, it’s essential to consider how each ETF allocates its funds across different company sizes. This allocation influences both the risk and potential return of the investment.
Company Size Distribution
The following table presents a detailed view of how investments in VCN and XIC are spread across large-cap, mid-cap, and small-cap companies:
| Company Size | VCN Number of Holdings | VCN Size Allocation | XIC Number of Holdings | XIC Size Allocation |
|---|---|---|---|---|
| Large Cap | 48 | 79.1% | 48 | 76.8% |
| Mid Cap | 99 | 18.7% | 108 | 19.3% |
| Small Cap | 38 | 2.2% | 80 | 3.9% |
| Total | 185 | 100.0% | 236 | 100.0% |
Sources: Vanguard Investments Canada Inc., Morningstar, Inc., as of September 30, 2022
Analysis of Holdings
- Large Cap Focus: Both ETFs heavily favor large-cap companies, with VCN allocating 79.1% and XIC 76.8% of their assets to this category. This concentration in large-cap stocks indicates a preference for stability and lower volatility, which large, established companies typically offer.
- Mid Cap Representation: Mid-cap companies, while less represented, still play a significant role, especially in XIC, which allocates nearly 19.3% of its assets to these firms, compared to 18.7% in VCN. These companies offer a balance between the high growth potential of small caps and the stability of large caps.
- Small Cap Inclusion: Small caps, although making up a smaller portion of the funds, are more significantly represented in XIC at 3.9% compared to 2.2% in VCN. This slightly higher allocation could contribute to enhanced growth potential, albeit with increased risk.
Implications for Investors
The dominance of large-cap stocks in both ETFs suggests that investors in VCN and XIC can expect relatively stable returns, though perhaps with limited upside potential associated with rapid growth. The greater diversity in company size within XIC, particularly with more small-cap stocks, might appeal to investors looking for slightly higher growth opportunities, though this comes with higher volatility.
For investors, understanding this breakdown is crucial for aligning their portfolios with their risk tolerance and investment goals. While the overall market-cap weighted strategy ensures that both ETFs are primarily influenced by larger companies, the subtle differences in mid-cap and small-cap allocations between VCN and XIC could influence investor preference depending on their investment strategy.
Historical Performance and Risk Analysis of VCN and XIC
The following analysis showcases the growth trajectory of investments in the Canadian equity indexes tracked by VCN and XIC from January 1, 2004, to December 31, 2021, highlighting their resilience and potential risks.
Growth of $10,000 Investment
The chart below illustrates the growth of a $10,000 investment in both the S&P/TSX Capped Composite Index (tracked by XIC) and the FTSE Canada All Cap Domestic Index (tracked by VCN), showing a similar annualized return of 8.4% for both over the period.
Sources: Morningstar Direct, DFA Returns Web Canada
Performance Insights
- Both ETFs show robust long-term growth, reflecting the overall health and expansion of the Canadian stock market over nearly two decades.
- Despite fluctuations, including significant market downturns, the compounded annual growth rate (CAGR) demonstrates solid returns, underscoring the potential benefits of long-term investing in these broad-market Canadian equity ETFs.
Risk Considerations
Investing in these ETFs also involves certain risks, as evidenced by historical losses:
- Global Financial Crisis: During this period, XIC experienced a dramatic drop, losing nearly half of its value, which mirrors the downturn seen across global markets.
- COVID-19 Pandemic: More recently, both ETFs suffered losses around 37%, highlighting the volatility and market sensitivity to global crises.
Future Expectations
Investors should be prepared for similar fluctuations and drawdowns in the future, as stock market investments inherently involve risk, particularly evident during economic downturns:
- Market Recovery: Post-crisis recovery phases have historically resulted in robust market upswings, as demonstrated after the 2008 and 2020 downturns.
- Strategic Planning: Understanding the cyclic nature of markets can aid investors in preparing for and navigating through periods of volatility, enhancing their ability to maintain a long-term perspective on their investments.
Understanding Market Volatility and Sector Concentration
Global Financial Crisis vs. COVID-19 Pandemic Impact
The resilience of ETFs during market downturns is critical for investors. Both the S&P/TSX Capped Composite Index ETF (XIC) and the FTSE Canada All Cap Index ETF (VCN) have experienced significant drawdowns during major economic crises:
- Global Financial Crisis: XIC suffered a substantial loss of -48.3%, highlighting the high volatility in Canadian markets during global economic downturns.
- COVID-19 Pandemic: Both ETFs faced declines, with XIC at -37.1% and VCN closely following at -37.2%. This illustrates their vulnerability to sudden market shifts but also their quick recovery alongside market corrections.
These figures underscore the importance of preparedness for similar market movements as part of a long-term investment strategy.
Sector Concentration in Canadian vs. Global Markets
A notable aspect of the Canadian stock market is its heavy concentration in specific sectors, which can significantly impact the risk and return profile of investment portfolios:
- Canadian Stock Market: Dominated by Financials (33.2%), Energy (18.9%), and Materials (13.1%), leading to a total concentration of 65.2% in these sectors. This reflects a significant risk if these sectors underperform.
- Global Stock Market: More diversified with Financials at 14.5%, Energy at 5.2%, and Materials at 5.1%, totaling a concentration of 24.8%.
This stark contrast shows the Canadian market’s over-reliance on a few sectors compared to the global market, which is more spread across various industries.
Diversification as a Risk Management Strategy
The high sector concentration in the Canadian market underscores the necessity for diversifying investments across a broader array of global sectors. By integrating ETFs that focus on foreign markets into your portfolio, you can mitigate the risks associated with the heavy sectorial concentration found in the Canadian stock market.
