How to Build an ETF Portfolio Around the iShares S&P/TSX 60 Index ETF (XIU)

Building a diversified ETF portfolio around the iShares S&P/TSX 60 Index ETF (XIU) involves understanding its foundational role within a Canadian investor's portfolio.

XIU, as Canada's first ETF and a pioneer globally, tracks the S&P/TSX 60—a market cap weighted benchmark of Canada’s largest and mid-cap stocks. It’s known for its tax efficiency due to qualified dividends, a reasonable 0.18% MER, and substantial liquidity with $14.5 billion in assets under management.

While XIU provides robust exposure to Canadian large and mid-caps, relying solely on this ETF may leave your portfolio lacking in diversification across geographical regions and sectors.

To create a more comprehensive investment strategy, it’s important to look beyond just Canadian equities. Integrating ETFs that cover international markets, including U.S., emerging and developed economies, can help mitigate risks. Here's how to get that done.

Vanguard S&P 500 Index ETF (VFV)

When considering U.S. market exposure, it's vital to acknowledge that it constitutes about 60% of the global market cap, making it a crucial component of any diversified investment portfolio.

The S&P 500 is a prominent benchmark in this context, composed of 500 large-cap companies listed on U.S. exchanges. This index is market-cap weighted, meaning larger companies have a greater impact on its performance, and selections are based on criteria like prominence, liquidity, and earnings.

A cost-effective way to gain this exposure is through Vanguard's S&P 500 Index ETF (VFV), which tracks this benchmark at a low expense ratio of just 0.09%. VFV essentially holds a U.S.-domiciled S&P 500 ETF, providing straightforward, direct exposure to the U.S. market.

However, there are a couple of caveats to consider: first, Canadian investors will incur a 15% withholding tax on dividends due to international tax regulations, which is unavoidable unless you hold the actual U.S. ETF in an RRSP.

Second, VFV is not currency-hedged. This means its performance can deviate from the actual S&P 500 index depending on currency fluctuations—benefiting when the USD strengthens against the CAD and vice versa. This factor should be considered based on your view of future currency movements.

BMO MSCI EAFE Index ETF (ZEA)

Expanding your investment horizons beyond North America is a smart move, and the EAFE region, which stands for Europe, Australasia, and the Far East, is a stellar choice for geographic diversification.

My top pick for accessing this market is the BMO MSCI EAFE Index ETF (ZEA), which captures around 85% of the market capitalization in these areas, focusing primarily on large-cap stocks.

A glance at ZEA’s sector and country distribution reveals a significant emphasis on Japan and the UK, alongside substantial allocations to other European nations like France, Switzerland, and Germany, and Oceania countries such as Australia.

The ETF includes well-known international companies like Novo Nordisk, Nestlé, ASML Holdings, AstraZeneca, Shell, LVMH, and SAP.

While ZEA is slightly more expensive than some domestic options, its expense ratio of 0.22% remains quite competitive within the sphere of international developed equity funds.

BMO MSCI Emerging Markets Index ETF (ZEM)

Emerging markets refer to countries that are in the process of rapid industrialization and have high potential for growth. These markets include major economies such as China, Taiwan, Brazil, India, South Korea, Russia, Saudi Arabia, and South Africa, among others.

Historically, accessing these markets might have been costly due to the complexities of investing directly in less familiar environments and varied regulatory frameworks.

However, ETFs like the BMO MSCI Emerging Markets Index ETF (ZEM) have made it significantly more affordable. For a reasonable expense ratio of 0.27%, ZEM offers Canadian investors an easy way to diversify their portfolios with emerging market exposure, encompassing a total of 769 holdings.

ZEM tracks the MSCI Emerging Markets Index, which is a market cap-weighted index featuring major companies such as Taiwan Semiconductor, Samsung Electronics, and Alibaba, providing broad exposure to a variety of sectors within emerging markets.

Putting it together

You can slice and dice it any way you prefer, but I like an allocation of 50% in VFV, 20% in XIU, 20% in ZEA, and 10% in ZEM. This setup mirrors the composition of many asset allocation ETFs with the usual home country bias towards Canadian equities, which improves tax efficiency and lowers currency risk.

With annual rebalancing and reinvested distributions, this portfolio strategy would have delivered an annualized return of 11.70% from February 14, 2014, to October 10, 2024, turning an initial $10,000 investment into $32,517.25.

I think that's quite impressive for a straightforward approach using just four low-cost index ETFs. With commission-free brokerages like WealthSimple, there's no reason why the average Canadian investor can’t easily implement this strategy.