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Varied ETF opinions agree on two points: lower fees, better returns

First, a bit of a confession: I have been spending a lot of time this summer on my own investing project - moving my money from mutual funds to exchange-traded funds. It's a decision that has been a long time coming, and for the last several weeks I have been reading anything I can get my hands on about ETFs and asset allocation.

More specifically, I'm trying to determine what percentage of my investments should be put in ETFs that track foreign markets, particularly emerging markets.

I've written about ETFs before: They're like mutual funds that trade like a stock, and are made up of baskets of stocks or bonds put together to mirror indexes. For example, you can buy ETFs that mirror the S&P/TSX composite index, or you can buy ones that track all of the world's stock markets, in proportion to the contribution that each country makes to the world's economy.

There are also hundreds and hundreds of other choices, from ETFs that track foreign currencies and bonds to those that mirror the stock markets of emerging countries.

So how to choose? It's been pretty overwhelming for me, but Daniel R. Solin, author of The Smartest Investment Book You'll Ever Read (Canadian Edition), says the decision can be easy. Mr. Solin believes Canadian investors can build diversified portfolios comprised solely of ETFs. Such portfolios would contain an ETF that tracks Canadian bonds and one that tracks Canadian stocks.

But Mr. Solin is also a firm believer that Canadians need to drop their home-country bias and broaden their investment horizons, so he advises people to take the total amount they want to invest in stock funds, and divide that into a 10/90 ratio - with 90 per cent going to foreign stock funds.

His book advises investors on specific funds, but he said in an interview this week that since the book was published, he has found two new foreign stock funds that Canadians should consider: the iShares MSCI ACWI index fund, put out by Barclays Global Investors, and the Vanguard Total World Stock Index Fund Investor Shares. Both are relatively low cost - with expense ratios of 0.35 per cent and 0.45 per cent respectively - but both also allow investors to buy into all world stock markets, in proportion.

To say that Mr. Solin has strong opinions is an understatement. Not only is he perfectly willing to advise investors exactly where they should put their money, he readily dismisses "hyperactive" brokers and investment advisers who he says are expensive and can't consistently pick great stocks or time markets because no one can.

In the case of foreign ETFs, his advice is to avoid trying to pick which geographical areas will outperform others. "What's going to drive prices isn't today's news or yesterday's news, it's tomorrow's news. If there's an earthquake in China or a terrorist attack in the United States, or if there's problems in the Middle East, that's going to drive prices. But that's unknowable, so smart investors don't get involved in that game, which is a very risky game."

Just days before I talked to Mr. Solin, I had a conversation with Tyler Mordy, director of research at Hahn Investment Stewards & Co. Inc., which is based in Victoria and Toronto. His shop specializes in foreign ETFs. Not surprisingly, he too is a fan of ETFs, but his approach is decidedly different.

He agrees with Mr. Solin that Canadians are homeland-centric and that mutual fund fees here are too high. But Mr. Mordy believes that individual investors should venture into emerging markets, to the tune of 10 or 20 per cent of their investments. He cites as an example his belief that Southeast Asia's proportion of world markets will triple in the next 15 to 20 years.

Hahn takes a more active approach to ETFs, which are traditionally seen as a passive instrument. In a recent paper called the "New Investment Landscape," Mr. Mordy describes the rise of emerging economies in Asia, where domestic consumption is increasing along with infrastructure, and capital markets are expanding. Compare that with the United States, where the financial sector is in disarray and where "a contraction in Wall Street structured finance is under way."

His advice to investors is to position portfolios heavier to emerging markets, as well as to large-cap equities in Western countries because they have fewer funding problems. And to keep financials underweight.

"We're definitely living in interesting times," Mr. Mordy says. Who can disagree with that?

Both men make persuasive arguments, but my decision will probably come down to the fact that the ETF portion of my portfolio is supposed to be my security blanket - the foundation that gets solid returns while I invest smaller amounts directly in the market.

I'm still giving myself a few weeks to decide the specifics, but I'm taking to heart their points of agreement - lower fees and better returns.

© 2007 The Globe and Mail. All rights reserved.

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