Vanguard FTSE Canada All Cap Index ETF (VCN) offers broad, market-cap-weighted exposure to Canadian equities at a razor-thin management expense ratio of 0.06%. The fund accurately represents the Canadian equity market and offers a sizable cost advantage against its peers, which makes it a compelling option within the Canadian equity universe and warrants a Morningstar Analyst Rating of Gold.
The fund's market-cap-weighting approach leads to the majority of its holdings landing in the giant- and large-cap bucket. However, this well-diversified portfolio of more than 200 stocks does have an allocation to both mid- and small-cap companies. The FTSE Canada All Cap Canada Index offers broader exposure of the Canadian stock market and better diversifies risk than the FTSE Canada Index, which is more concentrated and has a greater large-cap bias.
The fund has a relatively short track record. While it has tracked its index well thus far, the fund has underperformed the category average by 23 basis points annualized from its inception in September 2013 through September 2016. This underperformance is partially due to the exchange-traded fund's stock exposure within the energy sector as well as its higher exposure to both the energy and materials sectors.
As a resource-rich economy, commodity markets tend to be the single most important fundamental driver of the Canadian stock market. Canada is among the top oil producing and exporting countries in the world and is also a major producer of minerals, natural gas, and agricultural commodities. In total, Canadian materials and energy companies make up over a third of this portfolio. As such, weakening demand for commodities can hurt the performance of Canadian equity funds such as VCN. While there are no materials stocks among the fund's top 10 holdings, four energy companies are. These stocks include Suncor Energy (SU), the largest energy holding in the fund; midstreams Enbridge (ENB) and TransCanada (TRP); and exploration and production company Canadian Natural Resources (CNQ).
Aside from a major dependence on commodities, the FTSE Canada All Cap Index has considerable exposure to financials, with the sector alone making up 36% of the index. This exposure primarily comes through the country's commercial banks. Royal Bank of Canada (RY), Toronto-Dominion Bank (TD) and Bank of Nova Scotia (BNS) hold the three largest weightings, while Bank of Montreal and Canadian Imperial Bank of Commerce are not far behind as the sixth- and 11th-largest holdings in the fund. The banks benefit from a thicket of regulations that have historically kept competitors at bay and allowed incumbents to form an oligopolistic environment. The banks, owing to government restrictions, didn't participate in the toxic subprime market and emerged from the financial crisis as some of the strongest in the world. Despite their large size and historical success, Canadian banks may face potential pressure in different lines of business. Increased scrutiny over mortgage practices and mutual fund fees, heightened competition within the financial technology arena, and difficulties within the energy sector are some examples of where banks may be directly or indirectly impacted.
Overall, the financials, energy, and materials sectors make up almost 70% of the total portfolio. The index's substantial exposure to thesethe resources and financials sectors has made it sensitive to the business cycle. Ninety-two percent of the index is invested in either sensitive or cyclical sectors, while a mere 8% is invested in defensive sectors such as health care, utilities, and consumer defensives. This positioning indicates that the portfolio has considerable exposure to economic growth risk.
With a competitive annual management fee of 0.05% and a management expense ratio of 0.06%, VCN offers the same management expense ratio as comparable options, such as iShares Core S&P/TSX Capped Composite Index ETF (XIC) and large-cap-focused Vanguard FTSE Canada Index ETF (VCE). VCN is, however, significantly cheaper than iShares Core S&P/TSX 60 Index ETF (XIU), which charges 0.18%. As one of the cheapest Canadian equity index ETF options, it's not surprising that VCN also ranks well versus its active peers.
While VCN tracks the FTSE Canada All Cap Index, iShares and BMO have ETFs that track the S&P/TSX Capped Composite Index. Compared with VCN, BMO S&P/TSX Capped Composite Index ETF (ZCN) has slightly more exposure to mid- and small-cap names as well as less exposure to the financials sector. Over the three-year period ended Sept. 30, 2016 (the longest common period), the BMO ETF had a marginally stronger return compared with the Vanguard and iShares options.
For investors who want to limit their exposure to the large-cap Canadian equity market, there are XIU and VCE. The iShares ETF has a long track record and is the largest Canadian equity ETF available. The large size makes XIU a heavily used option for institutional investors looking to move large amounts of assets in short periods of time, but its high fee detracts from its appeal to long-term individual investors.
Similar to VCN, Bronze-rated PowerShares FTSE RAFI Canadian Fundamental ETF (PXC) offers broad exposure to the Canadian stock market. But instead of using a market-cap-weighting methodology, it weights its holdings according to fundamental measures of size, including book value, cash flow, sales, and dividends. PXC is more expensive than other Canadian equity ETFs, with a management expense ratio of 0.51%.
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