Investors who get exposure to Canadian equities through market-weighted exchange traded funds (ETFs) and even Canadian equity mutual funds might be surprised that one company has taken a more influential role in the benchmark S&P/TSX Composite Index.
That company is Shopify Inc. and it has jockeyed to become the second largest company listed on Canada’s premier stock exchange. At a market capitalization of nearly $2 billion, the e-commerce website accounts for 5.4 percent of the index behind Royal Bank of Canada at 6.9 per cent. Scandal-plagued TD Bank comes stumbling way behind in third at 3.9 per cent.
The online retailer has been nipping at RBC’s heels for a few years, but Shopify shares have doubled in value during the past six months on better-than-expected earnings and a positive sales outlook for the holidays.
The growth in Shopify shares has helped bouy the entire index - which is dominated by the well-known big banks, telecommunications companies and natural resource producers - to a 12 per cent gain over the same period. In market-weighted ETFs weightings in holdings like Shopify are adjusted each day based on their current market capitalization in the underlying index and are automatically boosted as share prices increase.
Diversification in an under-diversified index is a good thing but the dominance of Shopify brings a single company risk to an index that millions of investors normally rely on for stability and income.
We’ve seen this before over the past three decades with Nortel, Research in Motion (now Blackberry), and more recently Valiant Pharmaceuticals: all taking an outsized weighting in the TSX at some point in time.
If you are looking for an investment more reflective of traditional Canadian equities and not so closely tied to one company here are some alternatives.
Sector ETFs
ETFs that track specific sectors in the TSX Composite Index are available on the Canadian market. If Canadian financial, telecommunication or natural resource companies are what you want there are ETFs that exclusively track those sectors or sub-sectors.
Some Mutual funds
Canadian equity mutual funds could even be skewed toward Shopify if they are mandated to hold a minimum amount of Canadian equities simply because there are not a lot of Canadian companies to choose from.
Many Canadian equity funds actually track the TSX Composite like an ETF, but it is difficult to know how closely due to limited disclosure requirements.
Other actively managed Canadian equity mutual funds, however, can steer clear or limit the amount of index aberrations like Shopify if the manager wishes.
Active management has a price, though. Annual fees for equity funds could top 2.5 per cent of the total amount invested compared with fees of a fraction of a percent for ETFs. When you take fees into account, the average Canadian equity mutual fund underperforms the TSX Composite over several time periods.
Create your own Canadian equity fund
The least expensive, most transparent and most effective way to replicate the TSX Composite Index without Shopify in your portfolio is to simply cherry-pick the best stocks directly.
In the financial sector that could include the big banks; RBC, TD Bank, CIBC, BMO, Scotiabank and life insurance companies including Manulife Financial and Sun Life Financial.
The three main telecom companies on the TSX are BCE, Rogers Communication and Telus.
Big natural resource producers include Canadian Natural Resources and Suncor Energy but there are several to choose from.
Throw in Canadian National Railway and Canadian Pacific Kansas City and you have yourself a large cap Canadian stock portfolio.
If you want to own Shopify, buy it as a consumer stock along with other global retail stocks that trade on U.S. exchanges.
In any case, it helps to speak with a qualified advisor.
BNN Bloomberg is owned by Bell Media, which is a division of BCE.