September 2, 2014

Canadian Stock Market Explained


 

Since Canada has emerged from the recent global economic downturn relatively unscathed, many investors have been looking into the Canadian stock market.  All it takes is one peak at the TSX 60 (the Canadian equivalent of the Dow Jones Industrial Index) to realize that the Canadian stock market is heavily dependant on energy & materials, as well as their all-star banking sector.  In fact, at any given time energy and materials likely make up nearly half of the total capitalization of the Toronto Stock Exchange (TSX), while financials hold about 30% of the market.  Telecoms, utilities, railroads, and consumer discretionary/staples make up the rest.  Commodity prices generally drive the larger economy, and the TSX is known for listing the most energy stocks of any stock exchange in the world.  Keep this in mind if you are looking into broad-scale exposure regarding the Canadian market as it will be overweight in energy, materials, and financials by definition.

 

Income Trusts and REITS

 

One defining aspect of the Canadian Stock market has been its extensive range of income trusts and income funds available.  For those of you that are not familiar with these financial vehicles, they are essentially funds that were set up to provide investors with large rates of return in a tax advantageous situation.  Many of these trusts did this by using a return of capital format that dodged the double taxation that occurs when a business pays business taxes and then its shareholders have to pay dividend taxes as well.  In January of this year, new taxation rules on income trusts put a stop to this tax-avoidance structure with the exception of Real Estate Investment Trusts (REITs).  These funds hold real estate in trust and are required to pay out a certain percentage (usually 90%) of their income in the form of distributions to their shareholders each year.  Index funds and index trusts were very popular with investors looking for income from their investments, especially in times when the bond markets were down.

 

ETFs

 

Rather than try to pick certain stocks and use a labour-intensive means of trying to get broad exposure to Canadian stock market, many investors are choosing to simply pick one of the efficient ETF options that are offered.  Their low fees are very attractive, and their trade volumes mean that they are a very liquid asset.  The most popular is probably the iShares CDN LargeCap 60 Index.  It simply tracks the TSX 60 for a negligible fee.  The Claymore S&P/TSX Cdn Dividend tracks the Canadian Dividend Aristocrats Index and is another excellent choice.  Two other options are the Horizons AlphaPro Managed TSX 60 (more of a mutual fund/ETF hybrid), and the Claymore Canadian Fundamental Index.  All Canadian ETFs have holdings that are heavy in energy, materials, and financials due to the fact they make up such a large part of the Canadian market.

 

High Mutual Fund Fees

One reason why ETFs have been so popular in the Canadian market is because of the prohibitively high fees that Canadians pay on mutual funds.  Management fees of over 2.5% are not uncommon, and they are commonly ranked as the most expensive in the world.  Plainly the utility and efficiency advantages of exchange traded funds would be very appealing in this environment.

 

Canada’s stock market could be considered volatile in some areas due to the extremely heavy reliance on three main sectors (two if you consider materials and energy to be one-and-the-same).  The TSX does tend to move up and down with the price of commodities such as Uranium, Copper, Nickel, Gold, and especially oil.  On the other hand, Canada offers a stable geographical position in the world, a government system with a long track record of overall responsibility, a well regulated and efficient banking system, and a relatively well educated population that gives our investment options solid backing.

 

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