Breaking up with XEQT: How to Replace the iShares Core Equity ETF Portfolio

So, I recently discovered a Canadian investing subreddit called r/JustBuyXeqt, focused entirely on the iShares Core Equity ETF Portfolio (XEQT).

While it's interesting that such a diversified asset allocation ETF has its own dedicated group, it serves as a reminder that investing is not a team sport. Independent thinking is crucial, especially in financial decisions. Groupthink is universally bad.

That said, for those who may not feel too aligned with the "just buy XEQT" mantra and want to explore other avenues, here's a guide to a more hands-on investment approach.

Note: XEQT is an excellent option for beginners or those who prefer a hands-off strategy. The alternatives I will discuss might save you a bit on fees and offer more control, but they also add complexity.

What is XEQT?

XEQT is one of Canada's all-in-one asset allocation ETFs, specifically tailored for long-term investors with a high tolerance for risk. Launched in August 2019, XEQT is an equity-only ETF, meaning it invests 100% in stocks to maximize growth potential.

Structured as an ETF of ETFs, XEQT holds a diversified mix of other U.S. and Canadian listed iShares ETFs, breaking down as follows:

1. iShares Core S&P Total U.S. Stock Market ETF (ITOT) - 45%
2. iShares S&P/TSX Capped Composite Index ETF (XIC) - 25%
3. iShares MSCI EAFE IMI Index ETF (XEF) - 25%
4. iShares MSCI Emerging Markets IMI Index ETF (XEC) - 5%

This composition allows XEQT to cover U.S., international developed, and emerging markets, offering a broad global exposure. Additionally, the ETF includes a Canadian home country bias, which helps lower currency risk and improve tax efficiency for Canadian investors.

The expense ratio for managing XEQT is relatively low at 0.20% MER – and yes, this is inclusive of all fees charged by the underlying ETFs. Over the last five years, it's returned an annualized 11.77%.

Option one: XAW and XIC

The simplest way to reconstruct XEQT would be using the iShares Core MSCI All Country World ex Canada Index ETF (XAW).

This ETF tracks the MSCI ACWI ex Canada IMI (investable market index) as a benchmark, which encompasses over 8700 stocks from both developed and emerging markets worldwide, excluding Canada. It charges a management expense ratio (MER) of 0.22%.

Pair XAW with XIC to reintroduce that Canadian home country bias—essential for tax efficiency and reducing currency risk. To mirror XEQT, allocate 75% to XAW and 25% to XIC, resulting in a weighted average MER of just 0.18%. This setup could yield some cost savings, especially with a commission-free brokerage like Wealthsimple.

Another benefit—or drawback, depending on your view—is the flexibility to adjust your home country bias. While Vanguard and iShares typically maintain a Canadian allocation of 20-30%, you can choose to reduce this if less bullish on Canada. For instance, a 90% allocation to XAW with only 10% to XIC still represents an overweight to Canada relative to its global market cap weight of about 3%.

This approach could be a great step up for investors looking to slightly tinker with their portfolios while remaining disciplined. Managing just two ETFs isn’t overly complex, and both offer broad, low-cost market exposure.

Option 2: Buy U.S. ETFs

If you're not investing within a Registered Retirement Savings Plan (RRSP) or using a platform like Interactive Brokers that offers low-cost CAD to USD conversions, you might want to skip this section.

However, if you're looking to further minimize taxes and fees, consider splitting XEQT into its constituent ETFs. This approach takes advantage of lower MERs generally available in U.S. ETFs and avoids the 15% withholding tax on dividends that U.S. ETFs face outside of RRSPs.

Here’s how you can break down XEQT for an RRSP to save on fees and taxes:

1. 45% in RRSP – ITOT with a 0.03% MER. It benefits from no withholding taxes on dividends within an RRSP.

2. 25% in RRSP - Replace XEF with its U.S. equivalent, the iShares Core MSCI EAFE ETF (IEFA), which has a lower MER of 0.07% compared to XEF’s 0.22%.

3. 5% in RRSP - Replace XEC with the iShares Core MSCI Emerging Markets ETF (IEMG) at a 0.09% MER, which is lower than XEC’s 0.27%.

4. 25% in a Tax-Free Savings Account (TFSA) - Retain XIC at a 0.06% MER.

This new mix leads to a weighted average MER of just 0.0505%, significantly lower than XEQT’s 0.20%. Additionally, you recover around 0.186% in foreign withholding tax, calculated as 15% of ITOT’s 30-day SEC yield of 1.24%.

However, the effectiveness of this strategy heavily relies on having access to an RRSP and the ability to perform cost-effective currency conversions, for which platforms like Interactive Brokers are vital.