Fundamental vs Cap-Weight Portfolio: Still Neck and Neck after 20 Months

No Clear Winner Yet - Last time I reported on the contest in August 2011, the cap-weight portfolio had jumped into an inconclusive lead. The contest between portfolios made up of either fundamentally-weighted or cap-weighted ETFs continues without a clear winner. The portfolios, shown in detail in the Google Docs spreadsheet at the bottom of this blog page, have been updated with all distributions up to and including February 2012. The $85 separating the two portfolios' values is a miniscule 0.07% difference. Three of the fundamental ETFs are in the lead against their cap-weight rivals while four of the cap-weighted ETFs are ahead, but by lesser amounts.

Every Asset Class is Up - Our contest start date of June 2010 must have been a good time to get into the market since every ETF is above its initial start value. The portfolio as a whole has gained 16%, a very satisfactory result for less than two years in the market.

No Rebalancing Yet Required - None of the ETFs has deviated beyond the limit (more than 25% away from its target allocation e.g. a 4% holding can go up to 5% or down to 3% before our rule kicks in) we set for forced rebalancing. That has been the case since the start. Both portfolios are quite maintenance-free. There is cash building up however, and come the June anniversary date, it will be time to invest that cash into the ETFs that lag their target the most.

Lack of Automatic Reinvestment Warps the Comparisons - One of the difficulties with making head to head fundamental vs cap-weight comparisons between ETFs within an asset class is that the cash distributions do not get reinvested within the ETF. The market hype of the ETF providers use total return calculations which assume that the distributions do get reinvested when received. Our growing cash pile includes an important part of the ETFs' returns but the cash doesn't show in the current market value of the ETF shares that we use to do the Red vs Green who-is-ahead comparison. Since the ETFs do not distribute the same amount of cash, the total returns can be a fair amount out of whack with the Red vs Green indicator on my spreadsheet e.g. PXF distributed USD$404.82 in 2011 while its counterpart VEU paid out USD$644.80; VEU is much further ahead at the moment than the $124 showing in the spreadsheet. The truest comparison of my test is at the total portfolio level.

The best direct head to head matchup is between Canadian equity ETFs CRQ and HXT since in those cases, the dividends do get reinvested. In HXT's case, the construction of the ETF itself as a total return swap ensures that HXT's value reflects reinvested distributions. In CRQ's case, Claymore's free DRIP program buys new shares for the investor so all but a few dollars each quarter gets reinvested. Right now CRQ, despite its much higher MER, is winning the race by 2.6%.