Before BlackRock Canada created the iShares Core MSCI All Country World ex Canada Index ETF (XAW) back in 2015, we had no decent way to test our lung capacity. Can you say the entire fund name in one breath? ETF investors also were forced to strain their mental muscles, deadlifting a combination of several US, international and emerging markets ETFs and wedging them into one unwieldy portfolio.
These days, investors have it easier with XAW’s broad stock market exposure to over 8,000 companies around the globe. It excludes Canadian companies, so you’ll need an additional ETF for those, but the fund is still a welcome addition to most modest-sized portfolios.
Then again, the easy route isn’t always the best route for everyone. For example, tell your personal trainer you don’t need those sit-ups because you already did some last week. As your portfolio increases in size, it may be cheaper and more tax-efficient to switch back to the old-school way of doing things (i.e. buying separate ETFs for your US, international and emerging markets exposure).
But how do you get started with a new portfolio fitness regime, once you’ve gotten so used to working with a single global equity ETF?
Sweating the details
As with any bundled product, it can be difficult to understand what you’re actually buying. Reviewing the ETF’s website is a good starting point, but to really get it, I recommend rolling up your sleeves and checking out the index that the fund tracks (as well as the individual US, international and emerging markets equity sub-indices).
Working out with the weight of the world
XAW follows the MSCI ACWI ex Canada IMI Index. “ACWI” stands for “All Country World Index,” which means that it includes companies in both developed and emerging markets. “IMI” stands for “Investable Market Index,” which means that it tracks large-, mid-, and small-sized companies.
The MSCI ACWI ex Canada IMI Index can be broken down further into three sub-indices:
- The MSCI USA IMI Index (which tracks US stocks)
- The MSCI EAFE IMI Index (which tracks stocks in developed markets, excluding North America)
- The MSCI Emerging Markets IMI Index (which tracks stocks in emerging markets)
To determine how much weight each of these sub-indices represents in the overall parent index, we’ll follow these steps:
Step 1: Download the index fact sheet for the MSCI USA IMI Index and obtain the market capitalization in US dollars. (As of September 29, 2017, this figure was $25,959,263.89 million.)
Note: Instead of using MSCI’s search function on their site, I tend to just Google the name of the index, followed by “fact sheet”.
Step 2: Download the index fact sheet for the MSCI EAFE IMI Index and obtain the market capitalization in US dollars. (As of September 29, 2017, this figure was $16,867,756.65 million.)
Step 3: Download the index fact sheet for the MSCI Emerging Markets IMI Index and obtain the market capitalization in US dollars. (As of September 29, 2017, this figure was $5,761,814 million.)
Step 4: Add together the market capitalization figures from steps 1–3, which should equal $48,588,834.54 million. This is the market cap of the MSCI ACWI ex Canada IMI Index. (To double-check this figure, download the index fact sheet for the MSCI ACWI ex Canada IMI Index.)
Step 5: Divide the market cap of each sub-index by the market cap of the parent index. For example, to determine the weight of the MSCI USA IMI Index in the MSCI ACWI ex Canada IMI Index, divide $25,959,263.89 by $48,588,834.54, which equals 0.5343, or 53.43%. The MSCI EAFE IMI Index and the MSCI Emerging Markets IMI Index account for the remaining 34.71% and 11.86% of the MSCI ACWI ex Canada IMI Index, respectively.
Composition of the MSCI ACWI ex Canada IMI Index
| Index | Asset Class | Number of Companies | Market Cap (USD Millions) | Allocation % |
|---|---|---|---|---|
| MSCI USA IMI Index | US Stocks | 2,446 | $25,959,263.89 | 53.43% |
| MSCI EAFE IMI Index | International Stocks | 3,178 | $16,867,756.65 | 34.71% |
| MSCI Emerging Markets IMI Index | Emerging Markets Stocks | 2,667 | $5,761,814.00 | 11.86% |
| MSCI ACWI ex Canada IMI Index | Global Stocks (ex Canada) | 8,291 | $48,588,834.54 | 100.00% |
Source: MSCI index fact sheets as of September 29, 2017
Now that we know the weights of the various asset classes that XAW tracks, we can select the Canadian-listed and US-listed ETFs that most closely resemble the sub-indices:
| Sub-Index | Canadian-Listed ETF | US-Listed ETF |
|---|---|---|
| MSCI USA IMI Index | iShares Core S&P U.S. Total Market Index ETF (XUU) | iShares Core S&P Total U.S. Stock Market ETF (ITOT) |
| MSCI EAFE IMI Index | iShares Core MSCI EAFE IMI Index ETF (XEF) | iShares Core MSCI EAFE ETF (IEFA) |
| MSCI Emerging Market IMI Index | iShares Core MSCI Emerging Markets IMI Index ETF (XEC) | iShares Core MSCI Emerging Markets ETF (IEMG) |
Putting the program together
In my next blog post, I’ll show you how you can replace your XAW ETF holdings with a combination of these ETFs, to potentially pump up the money you might save on fees and foreign withholding taxes.
Hi Justin. Thanks for all your work. Questions:
I’m considering weighting my portfolio closer to a GDP based model. I see some intuitive value to this:
1. The US contributes about 24% to GDP but has 55% weighting in MSCI ACWI all-cap all-world index. That seems overweight.
2. Emerging markets contribute about 40% to GDP but have about 12% weighting in MSCI ACWI all-cap all-word. That seems underweight.
Given US equities are valued almost 2x than EM (perhaps merited perhaps not), there could be a counter-cyclical benefit to weighting a portfolio more inline with countries’ economic contribution. Also, 90% of the world’s population will live in EM in coming years and that seems to be a rationale to weight them accordingly.
CAN makes up about 2% of GDP yet most investors are home biased and overweight it incredibly high. I know you suggest it lowers variance and have allocated as much as 30%.
I would think a Canadian may not need any exposure to home equity markets because if the Canadian economy does well then the CDN $ rises enabling an individual more foreign equity purchases. Also, roads, hospitals, healthcare, etc., are likely to improve and in the end that is a quality of life increase we are ultimately trying to buy with our money. The only reason I see to have any CDN exposure is the preferential dividend tax treatment.
Do you think my strategy of shifting my portfolio closer to GDP contribution is flawed? There are not many people doing it.
Thanks again.
-Tom
Hi Justin,
Looking closer at US diversification today I came across something, suggesting long term returns of Value ETFs and Small Cap ETFs would have outperformed “S&P500” and “US total market index” (which sources data claims has minimal advantage over S&P 500, and under-represents these two Value-Based Tilted and Small Cap categories) rather consistently over the last 80 years. This sort of seems to conflict with your advice in this article regarding ITOTs diversification advantages?
I am extremely curious to hear your thoughts on small cap and value diversification? Am I missing something?
Weighing this advice against current strategy. I like ITOT and simplicity, but there seems to be one added fund which could incorporate some of this. I don’t want to blow my portfolio out to like 10 funds. But, I am thinking about splitting a % out of ITOT, and putting it into S&P 600 small-cap (IJR) or 600 small-cap value (IJS)?
Sources:
Link1 (this analyst adopt similar process): https://www.forbes.com/sites/robertberger/2017/06/01/total-u-s-stock-market-vs-the-sp-500-index-an-investors-guide/2/#593027b111c1
Link 2 (total market fund vs S&P500, compared to Small Value, Small ,Large Value): https://www.marketwatch.com/story/why-vanguard-total-stock-market-isnt-the-best-fund-in-the-fleet-2014-12-03?page=1
@Victor: I’ve written about tilting portfolios towards the small and value factors here: https://www.canadianportfoliomanagerblog.com/the-ultimate-buy-and-hold-portfolio/
Hi Justin,
A big thank you for all the hard work you and Dan are putting in for us DIY investors. Merry Christmas to both of you and your families.
A couple of quick questions:
a)You mention that the parent index consists of 3 sub indices. Where does it provide this info. In the fact sheet for the parent index, I did not see any such info.
b) If you look at the holdings section of the XAW ETF, it states 6 different ETFs such as IVV, ITOT, and so on. Should we not be looking at the respective indexes that these 6 ETFS are tracking, instead of the 3 sub indices mentioned?
Thanks again.
@Victor: Merry Christmas to you and your family as well :)
a) You have a dig deeper on the MSCI website in order to figure this out (I’ve already done the heavy lifting for you): https://www.msci.com/acwi
b) I wouldn’t – BlackRock Canada chose to use multiply US equity ETFs to mimic the exposure of the MSCI USA IMI Index (since they don’t have a specific ETF that tracks this index) – I don’t agree with their reasoning behind this. The S&P Total Market Index (which ITOT/XUU tracks) is extremely similar to the MSCI USA IMI Index, so either would arguably be a better proxy for the US equity exposure.
Excellent breakdown on this subject – thanks Justin.
At what size portfolio would it be good to switch out of XAW to the individual funds? You say XAW is good for a medium size. At what point should a person consider their portfolio large enough to switch? Many thanks.
@Rob: Great question – I’ll be answering this in my next blog post, so stay tuned.
Thanks Justin for another great article. I like the convenience of XAW but am aware of the higher fees being paid for this bundled product. Looking forward to the next blog post to learn about the foreign withholding taxes. It will perhaps steer me towards replacing XAW with a combination of the ETFs you described above. Quick question – will the foreign withholding taxes apply in the same fashion if the ETFs are held within a registered account vs non-registered account?
@Derek: The foreign withholding tax difference between holding XAW instead of the three Canadian-listed foreign equity ETFs in a non-registered account is expected to be zero (the only difference would be slightly lower product fees of holding the three individual ETFs). The same is true for TFSA accounts. The biggest benefit (in terms of foreign withholding taxes and product fees) comes from holding the three individual US-listed foreign equity ETFs in your RRSP account (instead of XAW) – as long as you use Norbert’s gambit to convert your currency.
Hi Justin,
Thank you for this article, I was hooked reading it from the first word, specifically because I invest in XAW (currently within my TFSA).
Reading your last reply to Derek’s post, when you say “as long as you use NG to convert your currency” within an RRSP, when exactly would you do that? For example, and please keep in mind, I’ve done NG before in my non-registered account (both CAD->USD and USD->CAD), would I do that once I’ve accumulated a certain USD amount within the account or after each trade (assuming its large of course) or years later when approaching or approached retirement and starting to withdraw from the account?
Really looking forward to your next follow-up blog post, as I had the exact question Rob asked.
Thanks again Justin for an amazing article!
@Vito: Most brokerages offer Canadian dollar and US dollar RRSP accounts. When investors contribute to their RRSP account, it is typically with Canadian dollars. In order to convert those Canadian dollars to US dollars (to purchase US-listed ETFs in your USD RRSP account – which reduces your product fees and foreign withholding taxes), you would need to either request that the brokerage convert the CAD cash for you at their FX rates (very expensive!) or use the Norbert’s gambit strategy to convert your loonies to dollars at a much better rate.
If you’re just going to accept the brokerage rate (by either having them convert it, or purchasing the US-listed ETF in your CAD RRSP account, which forces the currency conversion), this will offset the benefit from using US-listed ETFs in the first place (so you may want to just stick with XAW).
Understood, I apologize, I believe I mis-read and therefore misunderstood your reply to Derek, but your last reply to me just answered some internal questions, so thank you.
I do still have the same question that Rob posed, and thus really looking forward to your next post.
Thanks again Justin!
@Vito: You’re very welcome!