The fund provides exposure to many of the largest companies in Canada. Given its narrow focus, with 80% concentrated within three sectors of the economy, and the fact that Canada represents only a very small part of the global economy, the fund is best used as a tactical tool. Investors that are bullish on commodities may view Canada as an attractive alternative to some emerging markets that carry greater political risk alongside their access to natural resources.
Over the last 20 years, the MSCI Canada Index has exhibited annualised volatility of 15.8%, versus 14.4% for the MSCI World. During the same period it has shown some diversification benefit, with correlations to the S&P 500 Index, the MSCI Europe Index and the MSCI World Index of 79%, 72%, and 81% respectively.
The fund does not intend to make any distributions; therefore it may not suit an investor looking for regular investment income.
Relative to much of the developed world, Canada’s economy has exhibited considerable strength in recent years. Favouring a system of national champions rather than regional middleweights, Canada’s large, conservatively-run and heavily regulated banks sailed through the global financial crisis unscathed. And thanks to a secular bull market in raw materials fuelled by rapidly-growing developing markets, the resource-rich country’s stock market has shown two decades of impressive results. GDP grew by 1.5% in the 12 months through the third quarter of 2012. Inflation, measured at 1.6% for 2012, is fairly benign, and the unemployment rate of 7.1% doesn’t look too bad.
That said, ratings agency Moody’s recently downgraded several of the country’s largest banks, citing exposure to a heavily-indebted Canadian consumer base. The domestic housing market has continued to march forward, barely pausing for breath at the depths of the global financial crisis in 2008. This continued growth has sparked fears of a property bubble; The Economist, for example, reckons Canada’s housing market is as expensive as the U.S.’s was prior to its collapse in 2007. Indeed, as measured against factors such as household income and rent, prices look very dear by both global and their own historical standards. In response, the federal government has taken a number of steps to cool things off, including reducing the allowable amortisation period for mortgages, and raising the down payment requirements. Still, the potential for a collapse in real estate remains a key risk for Canadian stocks, particularly the banks.
The Canadian economy is strongly linked to that of its much-larger neighbour, the U.S., which is far and away the biggest market for its exports.
Over the last 20 years the MSCI Canada Index has posted an annual gain of 9.20%, as measured in Canadian dollars, versus a corresponding local currency gain of 6.22% for the MSCI World. The Canadian dollar has strengthened immensely on the back of the same commodity story that has propelled the stock market. In the last 10 years it has risen by almost 60% against the U.S. dollar.
After bottoming out at 9.1 in February 2009, the price-to-earnings ratio for the MSCI Canada Index reached 14.5 in December 2012. Since 2007 it has averaged 15.1.
According to Morningstar equity analysts, top position Royal Bank of Canada stock is trading at a premium of 13.7% to what they estimate to be its fair value, and next-highest constituent Toronto-Dominion Bank is trading at a discount of 5.0%. Third-biggest holding Bank of Nova Scotia was trading at around fair value, using the most recent closing price at the time of writing.
The MSCI Canada Index is a free float market capitalisation-weighted index currently consisting of 97 securities and covering approximately 85% of the Canadian equity market. New entrants must pass minimum requirements for liquidity and length of trading history. The median market cap of the constituents is $7.6 billion.
The index is formally reviewed on a quarterly basis, although adjustments can be made at any time in the case of a significant corporate action. New size cut-offs are recalculated semi-annually. The on-going reviews are meant to ensure that eligible new stocks are added to the index, and that existing stocks continue to meet criteria. To control portfolio turnover, buffers are used for existing constituents, so that they are not immediately removed upon falling out of line with any of the index’s entrance criteria.
The Index is narrowly concentrated within three sectors of the economy. As of the end of December 2012, financials made up 34.6% of the total, energy made up 25.9%, and materials 18.6%. There was a fair bit of concentration at the individual holding level, with 39.6% within the top 10 names. Top individual constituents were Royal Bank of Canada at 6.9%, Toronto-Dominion Bank at 6.2%, Bank of Nova Scotia at 5.3%, and Suncor Energy at 4.1%.
The fund uses synthetic replication to provide exposure to the underlying benchmark, employing a combination of unfunded with funded swaps in a ratio that can change over time. As of January 29th, 2013, 79.1% of the index exposure was gained through an unfunded swap, and the remaining 20.9% via a funded swap. In other words, the fund held a portfolio of assets accounting for 79.1% of the fund’s value and a funded swap for the remaining 20.9%. UBS provides full transparency on the portfolio assets and the collateral backing the funded swap.
At the time of writing, the portfolio assets consisted mainly of Japanese and European equities from a diverse set of industries. Collateral consisted entirely of government and supranational bonds. The exposure to counterparty UBS AG is monitored daily by the collateral manager, Lantern, the portfolio manager, and the fund’s custodian, State Street Bank. Any exposure of the fund to the swap counterparty is 105% collateralised and whenever the marked-to-market value of the collateral falls below 105% of the counterparty exposure, additional collateral will be requested from the swap counterparty. Collateral is held via transfer of title in a segregated account with the fund’s custodian.
At the time of writing, the fund’s total level of collateralisation is 103.4%.
Under the terms of the swaps, counterparty UBS AG agrees to provide the fund with exposure to the total return of the underlying index, net of any associated taxes, costs, or fees. The return from the swap assumes that all dividends paid by the underlying stocks are reinvested in the index. The fund does not pay out any dividend distributions.
The fund is Irish-domiciled and has the Canadian dollar as its base currency. At the time of writing it had assets of C$287 million.
For its synthetic ETFs, UBS produces what it calls the “drag level” for each fund, rather than showing the total expense ratio (TER) as it is calculated by other providers. The “drag level” is a full tally of any fees or expenses charged to the fund over a 12-month period, including management fees and swap costs. It differs from a typical TER in that the latter does not usually include swap fees. Drag levels for each fund are reviewed by UBS on an annual basis, and may be changed once a year, but once set they will remain the same for the entire 12-month period.
This fund charges a drag level of 0.42%.
Additional costs potentially borne by the unitholder but not included in the drag level include bid-ask spreads on the ETF and brokerage fees when buy and sell orders are placed for ETF shares.
For exposure to large cap Canadian equities there are a number of choices. These include CS ETF(IE) on MSCI Canada, db x-trackers MSCI Canada TRN, HSBC MSCI Canada ETF, iShares MSCI Canada, and Lyxor ETF Canada (S&P/TSX 60). Of these, the UBS fund is the biggest. The funds with the lowest TERs are the db x-trackers fund and the HSBC fund, both at 0.35%.