The problem with sector ETFs, a bullish TSX outlook, and the TFSA crackdown – The Globe and Mail – Jul 4 2017

Published July 4, 2017 Updated July 4, 2017

The proven success of index-based passive investing strategies is predicated on extreme levels of diversification that allows investors to avoid money-losing investment decisions. For example, an investor buying an ETF tracking the S&P/TSX Composite doesn’t have to worry about banks outperforming mining stocks or whether the energy sector is poised to rally – they already own everything. Research has shown a clear reverse correlation between the number of transactions and performance – the more decisions an investor makes, the lower the likely returns will be.

This makes sector ETFs a difficult theoretical proposition. Buying a health care ETF, for instance, is likely to generate better returns than if the investor chose individual health care stocks themselves. But, this will be little solace if the sector drastically underperforms the S&P 500 or other broader benchmark. The decision to emphasize one sector over another, health care in this instance, endangers future returns.

The extended preamble above (editors call it ‘throat clearing’, usually in a tone of withering contempt) is to provide the necessary context to bring up the  PureFunds ISE Cyber Security ETF. The ETF’s largest holding is are Palo Alto Networks Inc., a company that designs software to protect corporate IT networks from hackers.

The sector is certainly topical, as the Wired Magazine report “The biggest cybersecurity disasters of 2017 so far” indicates, and big corporate spending increases in security are almost assured. As an investment, however, the ETF is subject to the same sector-specific risks described earlier. The spending could fail to materialize, could go elsewhere than to the companies in the ETF, or another trend in technology spending could take precedence.

The PureFunds ISE Cyber Security ETF has a lot going for it based on current trends and could turn out to be a very lucrative investment. But the added risk, as with all sector ETFs, requires constant monitoring and attention.

-Scott Barlow, Globe Investor market strategist

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The Rundown

The Canada Revenue Agency has demanded the return of more than $75-million as a result of audits it has conducted over the past five years of tax-free savings accounts, including some TFSAs that swelled to more than a million dollars through aggressive securities trading. The audits are prompting calls – especially from those in the financial advisory community – for better clarity on tax rules surrounding the popular investment vehicle, reports Clare O’Hara.

The second half of the year for Canadian stocks could look much different than the first, writes Tim Shufelt. And that’s a good thing.

First, the good news: According to Robert (Hap) Sneddon, stock markets are likely to go up again over the next six months or so as investors feast on growth stocks in areas such as financials, technology and even energy. However, the bad news, according to Mr. Sneddon, president and chief portfolio manager at CastleMoore Inc., is that a “reconciliation” may be coming in 2018. The Globe and Mail recently spoke with Mr. Sneddon, who manages just under $100-million in assets, about what he’s buying and selling, and about the one Canadian consumer stock he wishes he bought, which has more than doubled since he first looked at it.

To earn a decent return, you need to include risky assets such as stocks in your portfolio. Equally important, you have to hold onto those stocks in both good times and bad. That may be hard to do when it seems the stock market is getting overheated – and harder yet just after it has crashed – but in the long run, you will almost certainly be further ahead. Here are two charts that prove it.

What’s the best way to control currency risk while still partaking in the wider world of investing opportunities? Here are four suggestions from John Heinzl.

The rich are putting their cash to work in France, buying the nation’s equities and real estate. Brian Milner is back from the country and takes a deeper look why.

There are likely a number of reasons behind the relative underperformance of value shares, but one underappreciated driver is falling bond yields, argues Chris Horwood.

A reader reports that she had a nice little portfolio of ETFs going, but then started putting money into something she thought was better – TD e-series index mutual funds. Now, she has a question: Sell the ETFs and commit to e-series funds, or find some better ETFs? Rob Carrick has the answer.

Check out Jennifer Dowty’s Insider Report Tuesday of the stocks insiders are buying and selling.

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