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Avoid the volatility in Canada’s three biggest market sectors

By his count, market research analyst and adviser Michael Graham has been through 10 bear markets and six recessions. Not only has he survived that turbulent financial history, he’s managed to prosper, which suggests he’s done well for his clients.


Financials, Energy, and Materials make up 73.5 per cent of the S&P/TSX 60 Index. While this leaves little room for secondary industries to drive total returns, the big three sectors, for the most part, operate independently, providing a natural hedge against downturns in any one industry.

As May begins, modest year-to-date gains racked up by the S&P/TSX 60 have been wiped out, as issues specific to each industry seem to be simultaneously evolving into fundamental problems without easy fixes.

Following downgrades to Canada's biggest banks by S&P and Moody's, the International Monetary Fund cut its outlook for the national economy, citing the same risk factors, falling housing prices and sky-high consumer debt levels. These concerns finally seem to be overshadowing fairly sound earnings and increases to dividends announced at the end of the first quarter by Canada's big banks. Both the iShares S&P/TSX Capped Financials Index Fund and the BMO S&P/TSX Equal Weight Banks Index ETF are down 3.4 and 3.8 per cent since March 1, 2013.

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Canada's oil and gas sector has been struggling for a much longer period, as the quest to expand pipeline capacity, in order to eliminate the bottleneck for Western Canada's producers, depends on massive infrastructure projects that are both time and capital intensive, and beholden to government approvals. Over the last month, the BMO S&P TSX Equal Weight Oil & Gas Index ETF and the iShares S&P/TSX Capped Energy Index Fund are down more than 4 per cent, while the iShares Oil Sands Index Fund is down more than 7 per cent.

At the same time, mining companies focused on precious metals, already under significant downward pressure, are reeling from record-breaking declines in gold and silver commodity prices. While there are many theories trying to account for this unprecedented sell-off, there is no arguing that this sector's slide is extreme. Over the last month, the BMO S&P/TSX Equal Weight Global Gold Index ETF is down more than 21 per cent, the iShares S&P/TSX Global Gold Index Fund is down 22 per cent, the iShares S&P/TSX Capped Materials Index Fund is down more than 14 per cent, and the iShares S&P/TSX Global Mining Index Fund is down more than 10 per cent.

While it remains to be seen how long these three industries will be underwater, the one trait the majority of the underlying companies in these sectors have in common is relatively high-volatility. To avoid further losses, a simple solution can be opting for a Low Volatility ETF, which selects stocks with the lowest betas from the S&P/TSX Composite, resulting in portfolios that feature more promising recent track records and much different holdings.

With net assets of $81.9-million and a dividend yield of 2.9 per cent, the BMO Low Volatility Canadian Equity ETF has proven that it is more than just a safe haven. YTD this ETF is up more than 8 per cent. Over the last twelve months ZLB has appreciated more than 14 per cent. Consumer Staples represent the largest sector exposure (20.5 per cent), followed by Financials (18.7 per cent), Utilities (13.0 per cent), and Consumer Discretionary (12.5 per cent). The portfolio consists of 40 holdings, the largest position is in Fairfax Financial (5.1 per cent), with the likes of the Big 6 nowhere to be found.

Launched less than a year ago, iShares MSCI Canada Minimum Volatility Index Fund still has modest assets under management and offers some diversity to many of the large cap names that make up the bulk of the S&P/TSX 60, but also includes some overlap with ScotiaBank, BMO, and TD featuring in its top 10 holdings. Energy and Financials make up the biggest sector allocations, 21.3 per cent and 17.6 per cent respectively.

Launched in late April last year, PowerShares S&P/TSX Composite Low Volatility Index ETF also has modest assets under management, but features a competitive 3.9 per cent yield. Similar to XMV, some of its largest holdings also feature in the S&P/TSX 60, including BMO, CIBC, and TD.

Exiting sectors or concentrated funds that have been battered is a difficult decision. Eventually these industry groups are bound to recover. Unfortunately, the underlying problems associated with the biggest components of the S&P/TSX 60 are complex. Shifting to a Low Volatility ETF will provide safety and potentially higher returns as the added phenomenon of concurrence is compounding the significant challenges being experienced by Canada's benchmark index.

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ETFinsight is a website dedicated to helping Canadians connect with relevant ETF solutions. Read more at, follow us on Twitter@etfinsight and Josh Erhlich can be contacted at:

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