Canada's New Evidence-Based ETFs

0:00 Canada just got a new suite of ETFs that could

0:02 change how a lot of Canadian investors build their portfolios.

0:05 They have all the good aspects of index funds, low fees, low turnover,

0:09 and broad diversification while making some

0:11 evidence-based tweaks to improve expected returns.

0:15 If you've been watching this channel, you've heard me talk about ETF slop.

0:18 These ETFs are not slop, and I'm going to tell you why.

0:22 I'm Ben Felix, chief investment officer at PWL Capital,

0:25 and I'm going to tell you about the new Avantis ETFs from CIBC.

0:33 This video is not meant to make you drop

0:35 your index fund strategy and go allin on these new ETFs.

0:38 These funds won't be for everyone,

0:40 and lowcost index funds are still a sensible option for most people.

0:44 All I'm aiming to do in this video is tell you what these new funds are,

0:47 the theory and evidence supporting them,

0:48 and why they are an interesting development for Canadian investors.

0:52 That said, if you're currently holding VEQT or XEQT

0:55 or any of the other EQTs in your RSP,

0:57 TFSA, or or whatever, you'll want to pay attention.

1:01 I want to note this video is not sponsored.

1:03 I have no financial relationship with CIBC or Avantis

1:06 and have no conflicts of interest to disclose.

1:08 Before we can get into the funds themselves,

1:10 we have to talk about why they're worth talking about.

1:12 A lot of Canadians still invest in old school actively managed funds,

1:16 which represent over 80% of the Canadian

1:18 fund market based on year-end 2024 data.

1:21 Active management is, broadly speaking, a losing game.

1:24 Active managers rarely outperform the market,

1:26 especially over longer time horizons.

1:28 That means the vast majority of Canadian investors

1:30 are still paying well over 1% in fund fees,

1:33 probably to one of the big five Canadian banks,

1:35 to probably underperform the market.

1:38 Not a great situation,

1:39 but there are better alternatives increasingly gaining traction today,

1:42 like lowcost index funds.

1:44 Lowcost index funds have been consistently gaining market share

1:47 since they were first launched by Vanguard in 1976.

1:50 An index fund simply replicates the holding of an index,

1:53 which is a list of stocks designed to represent a stock market.

1:57 Index funds make sense because they keep costs

1:59 low and capture the returns of the broad

2:01 market rather than unsuccessfully trying to beat

2:03 it like act like actively managed funds do.

2:06 This works as long as markets are efficient.

2:08 And active managers, to their credit,

2:10 actually keep markets efficient through all the analysis, trading,

2:13 and stock selection they do in their effort to outperform,

2:17 even though that effort doesn't usually

2:18 deliver excess returns after fees to investors.

2:21 Active investors effectively pay for the cost of keeping

2:24 markets efficient in exchange for a tiny chance of outperformance,

2:27 while index funds reap the benefits.

2:29 Index funds are the investing equivalent of never

2:32 interrupt your enemy when they're making a mistake.

2:34 All that said, index funds, well, in my view,

2:36 a huge upgrade from traditional active management for most

2:39 investors most of the time, are not perfect.

2:41 Many index funds track an index

2:43 that weights its holdings by their market capitalization.

2:46 They are cap weighted.

2:48 This means that index funds will hold more weight

2:50 in the biggest stocks and less weight in the smallest stocks.

2:52 There's nothing inherently wrong with market capitalization waiting.

2:55 Owning the market gives you exposure to the equity risk premium,

2:58 which has historically delivered solid long-term returns for investors.

3:02 But since index funds were first created in the 1970s,

3:04 financial economics has identified other return premiums.

3:08 Premiums the typical index fund Canadians

3:10 are increasingly investing in do not capture.

3:13 Basically, we've known for a long time

3:14 that stocks have higher expected returns than bonds,

3:17 which makes sense in theory and has worked out in practice.

3:20 But we also know that certain types

3:22 of stocks have higher expected returns than others.

3:25 By tilting your portfolio toward these types of stocks,

3:27 you can capture higher expected returns.

3:30 The same theoretical principles that explain why stocks should outperform bonds

3:35 also tell us that some types of stocks should outperform others.

3:38 I did a deep dive on this in a recent video about the famous

3:41 1993 FMAN French paper on the common risk factors in stocks and bonds.

3:45 In short, theory supports different expected returns across

3:49 stock types and the empirical data backs it up.

3:52 The other issue is that index funds also by their nature

3:54 of tracking an index trade when the composition of the index changes.

3:58 For example, if there is an initial public offering,

4:01 shares of the newly listed company will be added to many

4:04 indices and index funds will then buy them to match the index.

4:08 There are other examples too like existing companies

4:10 issuing more stock and companies buying back stock.

4:13 These are all changes in market composition.

4:15 Research on this suggests that the systematic

4:17 trading done by index funds to match

4:18 changes in market composition results in an implicit

4:21 cost of somewhere around 0.5% per year.

4:24 I did a whole video on this too if you want to learn more.

4:26 Between there being multiple known drivers of expected

4:29 returns that go beyond what cap weighted index funds

4:31 capture and index funds having their own implementation

4:34 quirks with implied costs that far exceed their fees.

4:37 Constructing a portfolio that improves on indexing

4:39 is an interesting premise that might

4:41 sound like active management which I just finished telling you does not work.

4:45 But unlike trying to pick stocks or time the market,

4:47 this approach is like a slightly more advanced version

4:50 of the principles behind market cap weighted index funds.

4:53 Investing this way still results in lowcost, broadly diversified portfolios,

4:57 but rather than just trying to capture

4:58 the equity risk premium while mechanically following an index.

5:01 It aims to capture multiple return

5:03 premiums while being intentional about implementation.

5:06 Dimensional Fund Advisors has been a leader in this space since 1981,

5:09 but their funds are not super accessible to Canadians.

5:12 Their products are mostly limited to financial advisors.

5:14 My firm PW Capital does make extensive use of Dimensional funds,

5:18 and I invest in them personally.

5:20 As always, Dimensional did not pay me to say any of this.

5:22 Dimensional did launch publicly available ETFs

5:25 in the US in 2020, but not in Canada.

5:27 As a result, Canadian investors without a financial

5:30 adviser had been left out in the cold.

5:32 With respect to this investment strategy,

5:34 I put together a model portfolio for Canadian investors back in 2020,

5:38 consisting of Canadian listed ETFs and two US listed ETFs.

5:42 I'll be the first to admit that the model portfolio was a bit clunky.

5:45 I think a lot of people might have tried to implement it and then abandoned it.

5:48 It did mean buying and rebalancing multiple ETFs,

5:51 dealing with currency conversion to purchase

5:53 US-listed ETFs and considering the foreign withholding

5:56 tax implications of US listed ETFs

5:58 of foreign stocks in some Canadian account types.

6:01 Blogger Rob Enen, who's a friend of mine,

6:03 predicted that there would be thousands of Ben Felix investing refugees who

6:08 tried to implement my model and then realized it was too much work,

6:11 later abandoning it in favor of easytouse asset allocation ETFs.

6:15 That's the good news is that a direct

6:16 competitor to Dimensional Fund Advisors, Avantis Investors,

6:19 has now launched Canadian listed ETFs,

6:22 including a single ticker asset allocation ETF like the EQT ETFs through CIBC.

6:28 Avantis has been around since 2019 when they

6:31 were launched by a group of former Dimensional employees,

6:34 including their former co-CEO and CIO, Eduardo Rapedto.

6:38 Avantis is sort of a new fund company,

6:40 but they exist inside of American Century Investments,

6:43 which has been around since 1958 and manages more than $300 billion today.

6:48 Avantis is cut from the same cloth as Dimensional

6:51 and is backed by a long-standing and a large asset manager.

6:53 Like, I think they're not going to disappear is the point there.

6:56 Dimensional and Avantis do each have their own flavor of the approach,

6:59 but the underlying principles are fundamentally similar.

7:02 This CIBC ETF launch is a big deal for a few reasons.

7:06 The Canadian listed products mean that Canadian investors don't

7:08 need to convert currency to buy them, which is great.

7:11 The Canadian listed ETFs hold securities directly,

7:14 which eliminates the double withholding tax concern for foreign stocks in TFSA,

7:19 RSP, and taxable accounts.

7:21 And the Canadian listed international funds carve out the Canadian

7:24 allocation while Canada is included in Aventus' US listed international funds.

7:29 Small detail, but it does matter.

7:31 What this means is that Canadian investors get a hassle-free way

7:34 to invest in this type of strategy without needing to use USlisted funds.

7:39 In the remainder of this video,

7:40 I want to walk through what some of these funds look

7:42 like and how they compare to market cap weighted index funds.

7:45 Then I'll get properly nerdy and explain

7:48 the underlying principles behind this approach in more detail,

7:51 which is important to understand for anyone

7:53 who wants to pursue this investment strategy.

7:55 One thing to note is that as I have mentioned,

7:56 these are not index funds since they don't track an index.

7:59 They do address one of the current concerns that many investors have.

8:02 They do not mechanically invest in the shares of newly

8:05 listed IPOs just because an index told them to.

8:08 I talked to Avantis about their approach here.

8:10 They don't have a blanket exclusion for newly listed companies,

8:13 which Dimensional Fund Advisors does,

8:15 and they will include them if they have enough information on their full set

8:18 of financials and the company trades

8:20 at an attractive price relative to those financials.

8:23 They are well aware of the issues around index

8:25 inclusion that I mentioned in my last video on IPOs,

8:28 and they're careful not to get caught up

8:29 in the mechanical price increases following index inclusion.

8:32 Before I walk through each fund, here's the mental model.

8:35 Every one of these funds does the same basic thing.

8:37 They tilt toward smaller, cheaper,

8:40 and more profitable stocks relative to their benchmarks.

8:42 The difference is how aggressively each one tilts

8:45 and which part of the market it covers.

8:47 The more aggressive the tilt, the higher the expected return,

8:50 but also the bigger the tracking error.

8:52 That's like performance that's different from the index.

8:55 Keep that trade-off in mind as I go through

8:57 each one because it does matter for investor psychology.

9:00 Okay, let's dig into what these funds look like under the hood.

9:02 Starting with CACE, the Avantis CIBC Canadian Equity ETF.

9:06 It has a management fee of 0.19%.

9:09 Note that the management fee is not the MER,

9:12 which can't be calculated until the fund has been operating for a while.

9:14 The ME will be slightly higher, but not too much,

9:17 roughly just by the amount of sales tax on the management fee.

9:20 This is a Canadian total market fund

9:22 that tilts moderately toward higher expected return stocks.

9:26 The way that this shows up in the fund's characteristics is that it

9:28 has a lower average market capitalization than the market cap weighted index,

9:32 meaning that it underweights larger stocks and overweights smaller stocks.

9:36 It has a higher average booktomarket ratio,

9:39 meaning that it overweights lowpriced stocks and underweights highric stocks.

9:43 and it has a higher average profitsto book ratio which means

9:47 that it is underweight less profitable

9:49 stocks and overweight more profitable stocks.

9:51 Overall you can see that the portfolio tilts smaller,

9:53 cheaper and more profitable than the Canadian market.

9:56 The biggest underweight is in mega cap

9:58 stocks with high prices and low profitability

10:00 and the biggest overweight is in small

10:02 cap stocks with low prices and high profitability.

10:04 This reflects the underlying principles of Avantis.

10:06 As I described earlier, this ETF's sector mix is generally pretty close

10:10 to the Canadian market with some overweights and underweights.

10:13 Before I continue, I do want to reiterate one

10:15 of the big trade-offs of setting portfolios up this way.

10:17 Being different from the market means you will perform differently from it.

10:21 Obviously, and increasingly so, the more different you are.

10:25 In the long run, we expect that difference

10:27 to be positive from the tilts that Avantis supplies.

10:29 But the reality is that there can be

10:31 long periods where tilting a portfolio towards smaller,

10:34 cheaper, and more profitable stocks leads to underperformance.

10:37 The US market has been a recent example

10:39 of this where the largest companies in the market,

10:41 often companies with high prices, have delivered exceptional returns.

10:45 Tilting away from those stocks and towards smaller and cheaper stocks,

10:49 has been painful for many years now in the US market.

10:51 Though it has paid off in other markets,

10:53 those performance differences relative to market indexes can

10:56 be really hard for some investors to live through.

10:59 If you're worried about short-term underperformance

11:01 and even the possibility of long-term underperformance,

11:03 this approach may not be for you.

11:06 If you're wondering whether this kind

11:07 of approach makes sense for your specific psychology,

11:09 account types, tax brackets, time horizon, all that kind of stuff,

11:13 this is the kind of question a good portfolio

11:14 manager can answer in the context of a financial plan.

11:17 There's a link in the description if you want

11:18 to talk to someone at my firm, PWL Capital.

11:21 Okay, onto the US equity funds from Avantis.

11:24 CLV, the Avantis CIBC US large cap value ETF.

11:28 It has a management fee of 0.25%.

11:31 It focuses on large cap stocks as the name suggests, but tilts towards smaller,

11:35 cheaper, and more profitable large caps while

11:37 excluding small stocks and high price stocks entirely.

11:40 Calv is similar to the USlisted AVLV,

11:43 which has beaten the US market since it launched in September 2021.

11:47 I know that's too short of a horizon to tell us anything useful,

11:50 but it's the data we have, and it's worth mentioning.

11:53 CAUS, the Avantis CIBC US all cap equity ETF has a management fee of 0.19%.

12:00 It's a US total market fund with moderate

12:02 tilts towards cheaper and more profitable stocks.

12:05 This is an interesting fund for total US

12:07 market exposure without taking on too much tracking error.

12:10 That's the performance differences relative to the market

12:12 since its tilts are not that aggressive.

12:14 Its USlisted equivalent has beaten the US

12:17 market since it it launched in September 2019.

12:20 C AUV, the Avantis CIBC US Small Cap Value ETF, has a management fee of 0.35%.

12:28 It's heavily tilted toward the smallest, cheapest,

12:30 and most profitable stocks in the US

12:31 market while excluding large stocks entirely.

12:34 This fund, while having high expected returns,

12:37 should be expected to have lots of tracking

12:39 error since it's very different from the market.

12:41 Its USlisted equivalent, AVUV,

12:43 has beaten the US market since it launched in September 2019.

12:47 But you can also see in the chart how

12:48 significant the performance difference has been over intermediate periods,

12:52 including some periods of underperformance.

12:54 The international funds follow a similar logic.

12:56 So I'll move through them a bit faster before getting to what is,

12:58 in my opinion, the most exciting fund in the lineup.

13:01 CADE is the Avantis CIBC International Equity ETF.

13:05 It has a management fee of 0.29%.

13:07 It invests in total market international developed

13:10 market stocks with a moderate tilt towards smaller,

13:12 cheaper, and more profitable companies.

13:14 It doesn't have an exact US-listed equivalent since CAD

13:18 as I mentioned earlier excludes Canada while the US listed

13:21 AVDE includes it but AVDE for what it's worth has

13:25 beaten international developed markets since it launched in September 2019.

13:29 CASV is the Avantis CIBC global small cap

13:33 value ETF with a management fee of 0.39%.

13:36 It offers exposure to a globally diversified portfolio

13:39 of small cap value stocks that emphasizes the smallest,

13:42 lowest priced and most profitable company.

13:44 Again, this fund should be expected to perform

13:46 very differently from the global stock market due

13:48 to its exclusion of the largest stocks and emphasis

13:51 on the lowest price and highest profitability small caps.

13:54 There's no US equivalent for CASV,

13:56 which includes US and international developed stocks.

13:59 But AVDV, the Avantis International Small Cap Value ETF,

14:03 which excludes US stocks,

14:04 has beaten international developed markets by a wide margin since it launched.

14:08 There's also an emerging markets fund CAEM with a management

14:11 fee of 0.39% for which the characteristics details have

14:15 not yet been published but it follows the same principles

14:18 of tilting toward higher expected return stocks across emerging markets.

14:22 The US listed version of this fund AVM

14:25 has outperformed cap weighted emerging markets since inception.

14:28 All those performance histories were short

14:30 since Avantis hasn't been around that long.

14:32 But if you want to see how

14:32 this investment approach has performed over the long run,

14:35 I detailed Dimensionals's long-term performance relative

14:37 to comparable Vanguard funds in another video, and they have decades of history.

14:41 I know that was a lot of tickers,

14:42 and your head might be spinning wondering how to use them,

14:44 which is why C A, the Avantis CIBC all equity asset allocation ETF,

14:49 is probably the most exciting product in the lineup.

14:51 It's like VEQT, Vanguard's equity asset allocation ETF,

14:54 but made up of the ETFs I just described.

14:57 So, you get exposure to a globally

14:58 diversified portfolio of stocks with a Canadian

15:01 home country bias and built-in tilts toward

15:03 the type of stocks I've been talking about.

15:05 This is a one-stop shop for a lowcost,

15:07 broadly diversified portfolio that takes full advantage of the last

15:10 30 years of financial economics research and mitigates the nuance downsides

15:13 of index funds all in a single ticker just like VQT

15:17 and XQT and all the other EQs that we have in Canada.

15:20 It even has its own subreddit just like the others.

15:22 To understand whether you should care about this, I'll get a little nerdy.

15:26 And by that I mean excessively nerdy since I

15:28 know you guys are into that kind of thing.

15:29 In their 2015 paper detailing their five factor asset pricing model,

15:33 Eugene FMA and Ken French explain the theoretical rationale

15:36 for the factors in their empirical asset pricing model.

15:39 The dividend discount model which is a model

15:41 for what the price of a stock should be says

15:43 that the theoretical value of a share of stock

15:45 is the discounted value of expected dividends per share.

15:48 Equation one here shows that the price M at time t is equal

15:51 to the expected future dividends per share discounted

15:54 at the long-term average expected stock return R.

15:57 Miller and Mediglani's famous 1961 paper showed that given investment

16:01 policy dividend policy is irrelevant to the valuation of shares.

16:05 Yes, this is the same reason that dividends are

16:07 irrelevant when evaluating the expected returns of a stock.

16:10 With dividend policy irrelevance, the value of expected dividends is

16:13 equal to expected earnings minus expected investment.

16:16 Following Miller and Mediglani,

16:17 the total market value of the firm stock is given by equation two.

16:21 Here we have the expected earnings and the expected change in book equity,

16:24 which is another way of saying asset growth or investment.

16:28 Scaling both sides of equation two by the book value of equity,

16:31 equation three gives the theoretical valuation equation as presented

16:34 by F and French in their 2015 paper.

16:37 This valuation equation makes three statements about expected stock returns.

16:40 One, if we hold everything in equation three constant except for the market

16:44 value of the stock M and the expected stock return R,

16:47 then a lower ratio of market value to book

16:50 value must imply a higher expected stock return.

16:53 All else equal, a company with a lower price must have a higher discount rate.

16:57 This is called the value premium.

16:58 Two, if we hold everything in equation three constant

17:01 except for expected future earnings and the expected stock return,

17:05 then higher expected earnings must imply a higher expected stock return.

17:08 All else equal, if two companies trade at the same price,

17:11 the company with higher profits must have a higher discount rate.

17:14 This is an expression of the profitability premium.

17:16 The discount rate is sort of interchangeable with the expected return.

17:20 Three, if we hold everything in equation three constant except for the expected

17:23 growth in book value of equity and the expected stock return,

17:26 then higher expected asset growth must imply a lower expected stock return.

17:31 All else equal, if two companies trade at the same price,

17:33 the company with higher investment must have a lower discount rate.

17:37 This is an expression of the investment premium.

17:40 To bring it back to the Avantis ETFs, they use these valuation concepts

17:43 to systematically tilt their holdings towards smaller,

17:46 cheaper, and more profitable companies,

17:48 targeting companies with quantifiably higher expected returns.

17:52 While the theory is there to support it,

17:53 the reason that these ideas are interesting

17:55 to investors is that these premiums have

17:57 existed in stock returns around the world as far back as we have data.

18:01 That does not mean that stocks

18:02 with these characteristics will always outperform.

18:05 They can have and have had some periods of severe underperformance,

18:09 but they have outperformed in the long

18:11 run and over most historical time periods.

18:13 An important insight from the valuation

18:15 equation and the observed empirical characteristics

18:17 of stocks is that the premiums should not be considered in isolation.

18:21 For example, a portfolio that focuses

18:23 on profitability without controlling for relative

18:25 price is likely to result in a portfolio of highpriced growth stocks.

18:29 Think overpaying for growth.

18:31 And a portfolio that focuses on value without controlling for profitability

18:35 is likely to result in a portfolio of stocks with weak profitability.

18:38 Think cheap for a reason.

18:40 These characteristics are related to each

18:42 other and those relationships can't be ignored.

18:45 The stocks with the highest expected returns in the market will tend

18:47 to be the stock with both low relative prices and robust profitability.

18:52 This makes targeting value and profitability jointly one of the most

18:55 important aspects of managing a portfolio

18:57 targeting these expected return premiums.

18:59 And it is exactly what Avantis is doing.

19:02 This isn't only about earning higher expected returns either.

19:04 It's about targeting multiple return premiums

19:07 that may show up at different times.

19:09 For example, over a period where the equity risk premium,

19:12 that is what you get with a market cap weighted index fund, does poorly.

19:16 Other premiums may do well.

19:17 It's not really diversification since we're not adding any new assets,

19:21 but it is providing access to more sources of expected return,

19:24 which can mean a more reliably positive long-term outcome.

19:28 One notable example is the US lost decade from 1999 through 2010.

19:33 The US market was flat for more than a decade, but small cap and value stocks

19:37 in the US delivered meaningfully positive returns.

19:40 There are other historical examples like this.

19:42 Japan being at least as interesting,

19:44 though it's important to keep in mind that small

19:45 cap value can also go through long periods of underperformance.

19:49 Lowcost market cap weighted index funds are sensible

19:51 investments for most people most of the time,

19:54 much more sensible than the traditional actively

19:56 managed funds that many Canadians still invest in.

19:58 But market cap weighted index funds are not perfect.

20:01 They offer exposure to a single expected return premium, the market premium.

20:05 But they ignore other wellestablished return premiums that can

20:08 be pursued systematically and at a low cost.

20:11 For many years, Canadians had to jump through hoops to invest this way.

20:14 But the launch of CIBC's Avantis ETFs

20:16 has made this investment approach more easily accessible.

20:19 One thing I mentioned earlier is that unlike index funds,

20:22 these Avantis funds don't mechanically buy IPO

20:24 stocks just because an index tells them to.

20:26 If you're holding VEQT or any cap weighted index fund in your RSP,

20:30 TFSA, or whatever account, that distinction may matter now more than ever.

20:34 Some of the largest private companies in the world, SpaceX,

20:37 OpenAI, and Anthropic among them are set to go public.

20:40 And when they do, your index fund may be

20:42 forced to buy their shares very likely at high prices.

20:47 It's worth understanding how that works and what

20:49 it could cost your portfolio in the long run.

20:51 That video is right