Investing in the Canadian stock market offers certain advantages, but diversification into U.S. equity markets through ETFs can broaden your investment scope and potentially reduce risk. This article explores U.S. equity ETFs provided by iShares and Vanguard, comparing their structures, performances, and strategic nuances. We’ll examine ETFs such as Vanguard U.S. Total Market Index ETF (VUN) and iShares Core S&P Total U.S. Stock Market ETF (ITOT), among others.

Why Consider U.S. Equity ETFs? Diversifying your investment portfolio beyond Canadian borders into the U.S. market can mitigate risks associated with market concentration and leverage growth opportunities in the world’s largest economy. Explore detailed insights into both Vanguard’s and iShares’ offerings in this comprehensive guide.

Overview of Key U.S. Equity ETFs

Here’s a comparison of four major U.S. Equity ETFs to consider for diversifying your investment portfolio across the U.S. market:

📌 Each ETF is marked with a flag indicating whether it is listed in the U.S. or Canada, helping investors quickly identify where each fund is traded. This selection of ETFs offers a broad exposure to the U.S. market and is managed with a focus on low expense ratios and significant asset management. This strategic approach aims to deliver performance that closely tracks their respective indices.

Detailed Composition of Major U.S. Equity ETFs

Below is an overview of the top holdings in four major U.S. Equity ETFs. This table reflects the proportion of each key asset within the ETFs, offering insights into their investment spread and focus:

Total Top Holdings % | | 23.1% | 23.0% | 23.3% | 23.9%

📌 This distribution highlights how these ETFs allocate their investments across leading U.S. companies, reflecting their strategy to balance significant holdings while ensuring a diversified portfolio. The similarities in percentage allocation across different ETFs underscore their comparable strategic approaches to the U.S. equity market.

Comparative Growth of $10,000 Investments in CRSP and S&P Total Market Indexes

This chart illustrates the growth of a $10,000 investment in the CRSP U.S. Total Market Index and the S&P Total Market Index from January 1, 2005, to December 31, 2021. Both indexes show a robust increase over the years, reflecting the potential of U.S. equity markets for long-term investment strategies.

Annualized Returns:

• CRSP U.S. Total Market Index: 11.1%
• S&P Total Market Index: 11.0%

The nearly parallel trajectories of the two indexes demonstrate their similar performance characteristics over the period, underscoring the effectiveness of these indexes in providing broad market exposure, including to smaller microcap stocks, which represent the smallest 3% of the market.

Understanding Total vs. Broad Stock Market Indexes

Total Stock Market Indexes: Total stock market indexes encompass a wide range of company sizes, typically including large-cap, mid-cap, small-cap, and micro-cap stocks. This comprehensive coverage aims to provide investors with a broad snapshot of the market’s overall performance, reflecting the inclusion of companies across all scales.

• Large Cap
• Mid Cap
• Small Cap
• Micro Cap

Broad Stock Market Indexes: In contrast, broad stock market indexes generally focus on larger segments of the market, primarily including large-cap and mid-cap companies, and occasionally small-cap companies, but they typically exclude micro-cap stocks. This focus tends to highlight more stable, established companies.

• Large Cap
• Mid Cap
• Small Cap

Comparative Analysis: Reviewing our four major U.S. stock market ETFs, we find a small allocation to micro-cap stocks, which is a distinguishing feature of total market indexes compared to broad indexes, such as those previously discussed for the Canadian market in our last blog. The inclusion of micro-cap stocks in total indexes can offer more diversity and potential growth opportunities, albeit with higher volatility.

This visual and textual breakdown helps clarify the distinctions between these two types of indexes, allowing investors to make more informed decisions based on their investment goals and risk tolerance.

Market Cap Allocation in U.S. Equity ETFs

Understanding the composition of an ETF in terms of market cap can provide investors with insights into its potential risk and return profile. Below is the market cap breakdown for each of the four U.S. Equity ETFs we have discussed:

VTI (Vanguard Total Stock Market ETF) and VUN (Vanguard U.S. Total Market Index ETF)

• Large Cap: 72.4% / 72.3%
• Mid Cap: 19.1% / 19.2%
• Small Cap: 6.3% / 6.3%
• Micro Cap: 2.2% / 2.2%

ITOT (iShares Core S&P Total U.S. Stock Market ETF) and XUU (iShares Core S&P U.S. Total Market Index ETF)

• Large Cap: 72.6% / 74.2%
• Mid Cap: 19.1% / 19.1%
• Small Cap: 6.2% / 5.2%
• Micro Cap: 2.1% / 1.4%

Each ETF maintains a composition that reflects its strategy and the index it tracks, with a heavier concentration in large-cap stocks, which tend to provide stability and consistent growth. Mid-cap stocks offer a balance of growth and stability, while small-cap and micro-cap stocks, although riskier, provide potential for higher returns.

Why Market Cap Matters: Market cap weighting in these ETFs means that larger companies have a greater impact on the ETF’s performance. As such, even though smaller companies (small-cap and micro-cap) are included, their influence is less pronounced due to their smaller market capitalizations.

This allocation strategy is crucial for investors seeking diversification across different market caps without significant exposure to the volatility associated with smaller companies. The inclusion of all cap sizes ensures that

investors can benefit from the growth potential of smaller firms while relying on the stability of large-cap companies.

Sectorial Exposure: Canadian vs. U.S. Stock Markets

The diversification of an investment portfolio across various market sectors can significantly impact its risk and return characteristics. Here, we illustrate the differences in sectorial exposure between the Canadian and U.S. stock markets:

Canadian Stock Market:

• Financials: 33.2%
• Energy: 18.9%
• Materials: 13.1%
• Total: 65.2%

U.S. Stock Market:

• Financials: 11.4%
• Energy: 4.7%
• Materials: 2.8%
• Total: 18.9%

Analysis: The Canadian stock market is heavily concentrated in three main sectors: financials, energy, and materials, which together make up 65.2% of the market. This high concentration can expose investors to higher volatility and specific sector risks, particularly in global economic downturns affecting these industries.

In contrast, the U.S. stock market presents a more balanced sectorial spread. Financials, while still significant, represent a smaller portion of the market, with energy and materials making up even less. This results in a total sectorial concentration of just 18.9%, highlighting a more diversified approach.

Exposure Strategy in ETFs: Our four discussed ETFs—VTI, VUN, ITOT, and XUU—reflect these market characteristics in their exposure strategies. VTI and ITOT, holding actual U.S. stocks, mirror the U.S. market’s diversified structure. Meanwhile, VUN, a Canadian-listed ETF, invests directly in VTI to replicate this diversification. XUU also aims to mirror the U.S. market, mostly through existing U.S.-listed ETFs, showcasing a strategy that balances sector exposure effectively across borders.

This comparison underscores the importance of considering sectorial exposure when choosing ETFs, especially for those looking to mitigate risk and enhance portfolio stability through geographical and sectorial diversification.

Exposure Strategies in Vanguard and iShares ETFs

Investing in ETFs often involves decisions about direct stock holdings versus the use of other ETFs to achieve market exposure. Here, we break down how Vanguard and iShares ETFs manage their U.S. equity exposures:

Vanguard ETFs:

• U.S. Equity Exposure through VUN and VTI:
  • Direct U.S. Stocks: Both VTI and VUN directly invest in U.S. stocks, ensuring close alignment with market movements.
  • U.S.-Listed U.S. Equity ETFs: VUN primarily achieves its U.S. market exposure by investing in VTI, its U.S.-listed counterpart, which simplifies its investment process and minimizes tracking errors.

iShares ETFs:

• U.S. Equity Exposure through XUU and ITOT:
  • Direct U.S. Stocks: ITOT directly holds U.S. stocks, mirroring the broad U.S. equity market.
  • U.S.-Listed U.S. Equity ETFs: XUU employs a blend of direct stock holdings and investments in various U.S.-listed iShares ETFs (such as IVV, IJH, IJR), increasing diversification but potentially leading to greater tracking errors compared to ITOT.

Comparison and Implications:

• The Vanguard strategy of VUN investing directly in VTI offers a streamlined approach that typically results in lower tracking errors due to the reduced complexity of managing one major holding.
• In contrast, iShares’ XUU, with its diversified investment approach through multiple ETFs, might offer broader exposure across different segments of the market but can experience higher tracking discrepancies compared to ITOT, which sticks more closely to direct stock holdings.

Tracking Performance:

• Especially in recent years, the strategy of using a mix of ETFs in XUU has resulted in slightly higher annual tracking errors compared to the more direct approach of ITOT and VUN’s investment in VTI.

This comparison highlights the importance of understanding the underlying exposure strategies of ETFs, as they can significantly influence both the performance and the tracking accuracy relative to the benchmark indexes.

Annual Return Comparison of Vanguard and iShares ETFs

The table below provides a clear comparison of annual returns for Vanguard ETFs (VUN and VTI) and iShares ETFs (XUU and ITOT), showcasing how minor differences in investment strategies can influence performance:

Vanguard ETFs:

• VUN (Vanguard U.S. Total Market Index ETF) vs. VTI (Vanguard Total Stock Market ETF):
  • The returns are closely aligned, with the most significant annual difference being only -0.5%.
  • These minor discrepancies are largely due to currency conversion rates and the inherent differences between being directly listed in the U.S. versus Canada.

iShares ETFs:

• XUU (iShares Core S&P U.S. Total Market Index ETF) vs. ITOT (iShares Core S&P Total U.S. Stock Market ETF):
  • Differences in returns range up to 1.5%, with XUU sometimes outperforming or underperforming ITOT by significant margins.
  • The variations can be attributed to XUU’s mixed approach of holding both direct stocks and other U.S.-listed iShares ETFs, which may lead to higher tracking errors.

Analytical Insights:

• While the annual differences might seem small, they can compound over time, affecting long-term investment growth.
• Vanguard’s strategy of directly mirroring its U.S.-listed counterpart in its Canadian ETF tends to maintain closer tracking accuracy compared to iShares, which utilizes a more diversified ETF strategy.

Long-term Implications:

• Despite these annual variations, both ETF providers offer robust returns, reflecting their effective market strategies. However, investors should consider these differences when choosing an ETF, especially if they are sensitive to tracking errors or are focused on specific investment outcomes.

This data underscores the importance of understanding the underlying mechanisms of each ETF, including how they are managed and how they gain exposure to the markets they track. Such knowledge is crucial for investors aiming to optimize their portfolios to suit their financial goals and risk tolerance.

Long-term Performance Review of Vanguard and iShares ETFs

We’ve analyzed the performance from February 10, 2015, to December 31, 2021, to understand how Vanguard and iShares ETFs have fared over the long term:

Vanguard ETFs:

• VUN (Vanguard U.S. Total Market Index ETF): Annualized performance of 14.28%
• VTI (Vanguard Total Stock Market ETF): Annualized performance of 14.54%
• Tracking Error: -0.26%, indicating a slight underperformance of VUN compared to VTI, likely due to the differences in market access and currency exchange.

iShares ETFs:

• XUU (iShares Core S&P U.S. Total Market Index ETF): Annualized performance of 14.39%
• ITOT (iShares Core S&P Total U.S. Stock Market ETF): Annualized performance of 14.59%
• Tracking Error: -0.20%, showcasing a minimal discrepancy between XUU and ITOT, reflecting efficient management and the benefits of their diversified investment approach.

Performance Insights:

• The ETFs from both Vanguard and iShares show robust long-term performance with slight variations between them. These differences highlight the subtle impacts of each provider’s unique strategies on their ETFs’ results.
• Despite minor tracking errors, all ETFs provided substantial growth over the analyzed period, demonstrating their effectiveness as tools for achieving diversified exposure to the U.S. stock market.

Risk Considerations:

• It’s crucial to note that all ETFs involved have faced significant market downturns, losing around 30-50% of their value during crises such as the Global Financial Crisis and the COVID-19 pandemic. This emphasizes the importance of understanding the inherent risks associated with stock market investments, regardless of the ETF provider.

This data serves as a testament to the resilience and performance consistency of these ETFs over a significant time frame, providing investors with valuable insights into potential long-term outcomes and the importance of considering both returns and associated risks.

Historical Volatility and Resilience of ETF Investments

Market downturns test the stability and resilience of investment strategies. The following data illustrates the peak-to-trough losses experienced by Vanguard and iShares ETFs during the Global Financial Crisis and the COVID-19 pandemic, highlighting the impact of major economic events on these investments:

Global Financial Crisis:

• VTI and ITOT: Both experienced a significant loss of 46.9%.

COVID-19 Pandemic:

• VTI: Loss of 28.8%
• ITOT: Loss of 28.9%
• VUN and XUU (Canadian ETFs): Both saw a similar decline of 28.5%.

These figures illustrate the critical importance of risk management and the need for diversification within investment portfolios. Despite substantial short-term losses, it is crucial to recognize that:

Stock Market Resilience:

• Over long periods, stock markets have historically delivered positive returns, reflecting the dynamic nature of global economic growth and innovation. The recovery phases post-crisis have often been robust, underlining the potential for growth even after significant downturns.

Strategic Considerations:

• Investors should be prepared for fluctuations and should consider these factors when planning long-term investment strategies. Understanding the historical performance during downturns can guide investors in building a resilient portfolio that aligns with their risk tolerance and investment horizon.

Moving Forward:

• Stock markets are cyclical, and while downturns are challenging, they are also natural parts of economic cycles. The resilience of markets suggests

that, with patience and strategic planning, investments can recover and potentially thrive over time.

As we have seen, both Vanguard and iShares ETFs have navigated through turbulent times with varying degrees of impact. Their performance, although temporarily affected during economic crises, demonstrates the strength and potential recovery inherent in diversified and well-managed portfolios.