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Changes to Barclays Canadian iShares XIC, XDV, and XTR
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Changes to Barclays Canadian iShares XIC, XDV, and XTR

Contributed by: martingale

Mutual Funds This is the third and final article on recent changes to the Barclays Canadian iShares (formerly iUnits) exchange traded funds. With respect to the Canadian equity market, there are three important changes to the Canadian iShares ETFs: Income trusts have been added to the TSX equity index (XIC), and there are two new equity index ETF's: A Canadian iShares fund specializing in dividend income (XDV) and a Canadian iShares fund specializing in income trusts (XTR). What do these changes to the Canadian equity ETF's mean for investors? The change to XIC is excellent news. The new XTR and XDV funds may be useful for some investors, but the average investor is better served by a straight equities index like XIC.



The general theory of investment is that you should diversify your holdings roughly in proportion to market capitalization. According to the theory, you should simply invest the Canadian equity portion of your portfolio in XIC and forget about everything else. It also means that Canadian equities should make up only a small part of your equities position, because Canada is only a small part of the global market.

From this theoretical perspective, the change to the XIC Canadian capped index iShares ETF is excellent news: Income trusts are an important part of the Canadian market that were missing from a portfolio based only on XIC. If you already had invested heavily in XIC my advice to you is to be happy, and do nothing.

Of course, that's just the theory. In practice everyone's financial situation is a bit different. The theory is provably correct for an "average" investor, but you are not average, and so your portfolio should be a little different too. There are many ways you could differ from average, but in this article I am going to conver just three common ones: Your tax situation, your retirement status, and your nationality.

The XIC, XTR, XDV Canadian iShares ETFs versus your tax situation

If all your investments are held inside an RRSP then from a tax point of view you can safely follow a truly global portfolio--your tax situation is neutral. In that case, it's safe to simply hold XIC in the correct proportion. However, if you have substantial investments outside your RRSP then you would want to overweight Canadian equities to take advantage of the dividend tax credit. You would plan to hold more Canadian equities than the theory predicts, and you might augment XIC with some XTR and XDV if it is tax advantageous for you to take a larger proportion of your return as dividend income rather than capital gains.

The XIC, XTR, XDV Canadian iShares ETFs versus your retirement status

As you approach retirement it is natural to want to want to switch your portfolio towards higher yielding securities to generate an income stream. This is partly a matter of preference--you could also simply sell shares and live on the capital gains. A corporation earns the same profits whether it pays a dividend or not, so this is really just a choice of how you want to receive the returns. Having a dividend income stream is simply a convenience--but if that convenience appeals to you, you could add some XTR and XDV to your portfolio to boost yield.

The Canadian Equity iShares ETFs versus your nationality

The theoretical "average" investor has an "average" nationality, but you are actually a Canadian. If you plan to spend your retirement in Canada then there is some argument that you should overeweight the Canadian dollar in your portfolio to limit your currency risk. I have argued many times that you should do this primarily with the bond part of your portfolio: Bonds are less volatile than equities are, and therefore bond diversification is a little less important than equity diversification. You can also consider the XSP and XIN iShares ETF's if what you want is a Canadian dollar denominated investment.

At any rate, the point here is that you might want to overweight Canadian equities in your portfolio on the grounds that you will retire in Canada. You would therefore buy more XIC than the average investor theory says. Don't go overboard loading up on Canadian dollar investments, though: The counter-argument is that you foreign holdings protect you from the risk of Canadian dollar inflation that could potentially ruin you financially.

Conclusion

For most investors the addition of income trusts to the iShares XIC ETF is great news. Most people can simply use XIC as their sole investment in the Canadian equities market. For people close to retirement, or who have non-RRSP investments, the new XDV and XTR ETF's do provide a useful tool to adjust the default XIC portfolio to your particular financial situation.
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