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How well ETFs tracked equity indexes in 2013

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Globe editors have posted this research report with permission of National Bank Financial. This should not be construed as an endorsement of the report's recommendations. For more on The Globe's disclaimers please read here. The following is excerpted from the report:

Canadian Equity:

Large Cap: HXT ranks highest with its synthetic structure while relative newcomer VCE tops the list of physical ETFs. HXT's extremely tight tracking is a direct consequence of its underlying swap structure, which delivers the total return of the index (with reinvested distributions) directly to the NAV of the fund, with the trade-off being derivative counterparty risk. In 2013, HXT lagged its index by 6 bps, with virtually no volatility around that figure (tracking error), because of its industry-low MER of 7 bps (5 bps after waiver).

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VCE from Vanguard follows close behind although it tracks a different index (FTSE Canada) with 77 constituents. Because it is relatively smaller, VCE has thinner trading than its peers which track the S&P/TSX 60. As a result, its premium/discount metrics were higher in terms of both average and variability, but they were still low enough to demonstrate excellent overall market making efficiency.

Broad: ZCN from BMO continues to impress as it had the best full 2013 performance of the broad Canada ETFs, in keeping with its low MER of 17 bps. Although it had a very slight but measurably higher variability around its excess return figures than closest peer XIC from iShares, the fee differential overwhelmed the tracking error and ZCN outperformed by the expected 10 bps in 2013. Not shown in the table is VCN,

Vanguard FTSE Canada All Cap Index ETF, which launched too recently for this analysis (August 2013), but which we will continue to monitor closely as an alternative for broad Canadian equity exposure.

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