Are You Ready For a Venture?

As I discussed in Monday’s post, an American ETF provider launched the Global X S&P/TSX Venture 30 Canada ETF (NYSE Arca: TSXV) on March 17, the first index fund pegged to Canada’s junior stock exchange. iShares has announced that it will launch its own the S&P/TSX Venture Index Fund (XVX) in the coming months.

These new ETFs give Canadian index investors an opportunity to access a whole new market that was previously off-limits to anyone who wasn’t willing to trade individual stocks. But before you decide to add one of these funds to your portfolio, understand what you’re getting into.

A risky Venture

The Venture exchange is a play on commodities. If you think the broad Canadian market is poorly diversified, it has nothing on the Venture market. All 30 of the companies in TSXV are involved in either mining or energy (oil and gas). So don’t make the mistake of thinking that this fund gives you broad exposure to small companies in all sectors of the economy.

These are really small companies. It’s a stretch to call these companies small caps — all but the largest Venture-listed companies are micro caps (worth less than $300 million), and TSXV includes several penny stocks (those with share prices under $1). Indeed, all 2,400-odd companies on the Venture exchange have a combined market capitalization of about $78 billion. That’s significantly less than the market cap of Royal Bank alone.

Buckle up for the ride. You can expect Venture-tracking ETFs to be much more volatile than a broad-market Canadian index fund. According to the prospectus for the forthcoming iShares ETF, companies on this exchange “are subject to substantially greater risks of loss and highly volatile price fluctuations because their earnings and revenues tend to be less predictable and their markets less liquid than companies with larger market capitalizations. These companies may also be highly speculative in nature and may not have established businesses.”

Tracking error could be significant. I would take a wait-and-see approach with any new ETF as small as TSXV. (The fund currently has less than $5 million in assets, and many of its holdings amount to less than $100,000.) The iShares ETF sounds more promising, given BlackRock’s long record of prudent management. But it remains to be seen whether a Venture ETF can ever have the economies of scale it will need to keep its costs low and its tracking error small.

Other ways to think small

If you want to tilt your portfolio to small-cap stocks, investing in the TSX Venture Exchange is not the way to do that: TSXV, at the end of the day, is speculative investment in 30 extremely small mining and energy companies, and it’s not appropriate for most index investors. There are much broader options for those looking for small-cap exposure:

• For Canadians, the iShares S&P/TSX Small Cap Index Fund (XCS) has more than 200 holdings and an MER of just 0.55%. Many of the companies are also part of the S&P/TSX Composite, though they carry more weight in this fund. Inevitably, XCS is skewed to mining and energy companies, too, but 40% of the fund is in other sectors.

• The US small-cap market is incredibly rich, and the Vanguard Small-Cap ETF (VB) gives you more than 1,700 stocks for just 0.14%. Energy and materials are small parts of this fund, whose largest sectors are financials and technology (each about 20%), health care, industrials and consumer goods.

• For global small-cap exposure, it’s hard to top the Vanguard FTSE All-World ex-US Small-Cap ETF (VSS). Canada actually represents the largest share of this fund, at more than 15%. The ETF includes more than 2,700 companies from around the world, with the greatest weight in the industrial, financial and consumer sectors. The MER is 0.33%.