IPOs, Indexing and Market-Linked GICs: Weighing Up Their Worth (EP.42)

Episode Summary

Executive Summary: This episode introduces a more structured format: current topics, one portfolio topic, one planning topic, and a weekly “worst advice” segment. The hosts discuss a Canadian lawsuit over closet index funds, the IPO boom and what the data says about IPO performance, the strongest arguments against indexing, account-ordering and tax-efficient placement of investments in Canada, and why market-linked GICs/structured notes are usually poor investor products.

Main Topics: New episode format and show updates: The hosts explain the new structure for non-guest episodes: two current topics, one portfolio topic, one financial planning topic, and one weekly worst-advice segment. They also mention listener feedback and growing downloads. Closet index funds and legal action in Canada: They discuss class-action lawsuits filed against RBC and TD Canadian equity funds over alleged closet indexing, noting that low active share and near-index exposure raise questions about fees versus delivered value. IPO frenzy and investor behavior: They examine the renewed IPO boom, whether investors should chase IPOs like Uber, Lyft, Slack, and Pinterest, and emphasize that indexed investors will eventually own newly public companies anyway. Arguments against indexing: The episode challenges common anti-indexing claims: that index funds are risky, that active management provides control, and that skilled managers will always beat the index. The hosts argue the evidence does not support these claims. Account-ordering and tax-efficient planning in Canada: They outline a practical hierarchy for funding accounts such as RRSPs, RESPs, and TFSAs, explain when debt repayment may be preferable, and discuss asset-location issues like withholding tax and U.S.-listed ETFs. Worst advice: market-linked GICs and structured notes: The hosts criticize market-linked GICs as complex products that cap upside in exchange for downside protection, usually benefiting banks more than investors.

Key Arguments: Closet index funds may be charging active-fund fees for portfolios that behave like the benchmark, which is unfair to consumers if active share is very low. In Canada, large mutual funds in a small market may be forced toward index-like holdings because of size and diversification constraints, making some closet indexing partly structural rather than intentional. IPO investing is usually not attractive on a broad basis: historical evidence shows IPOs tend to underperform over the first two years after going public. If you own broad index funds, you will eventually own successful IPOs after they are added to the index, so chasing the initial offering is rarely necessary. The main anti-indexing arguments fail because index funds are not uniquely risky, “control” over holdings has no demonstrated performance benefit, and persistent manager skill is hard to identify ex ante. Active management adds uncompensated active risk on top of market risk; because active returns are a zero-sum game after fees, average active results should lag the market. A long track record can still be luck: even famous managers with strong histories can later fail badly, showing that past outperformance is not reliable proof of skill. For account selection, RRSPs are usually best first for high earners, followed by RESPs (due to grants), then TFSAs; exact ordering depends on current and expected future tax rates. If tax rates are unchanged over time, RRSPs and TFSAs can be mathematically equivalent on an after-tax basis when comparing equal pre-tax amounts. Taxable accounts can be preferable for speculative individual-stock bets because losses are usable for tax purposes and registered-account room is not wasted on failed speculation. U.S.-listed ETFs can be more tax-efficient than Canadian-listed ones inside RRSPs due to withholding-tax treatment, but TFSAs generally favor Canadian-listed funds holding stocks directly. Market-linked GICs/structured notes usually exchange upside for downside protection and are therefore poor long-term investments for most people.

Data Points: Episode downloads per episode: around 1,300 - The hosts said each episode is getting roughly 1,300 downloads. Weekly downloads: around 3,000 per week - They noted total weekly downloads were nearing 3,000. Ontario title protection framework: will take a number of years - Ontario budget mentioned financial planner/advisor title protection but without immediate details. RBC Canadian equity fund MER: 0.77% - Used as an example in the closet-index discussion. TD Canadian equity fund MER: 1.0% - Used as an example in the closet-index discussion. Fund sizes discussed in lawsuit: $2.5 billion and $5 billion - The RBC and TD funds cited in the class action are very large for the Canadian market. Canadian equity mutual funds identified as closet indexers: 37% - A 2016 study cited by the hosts found that 37% of Canadian equity mutual funds were closet index funds. U.S. IPO sample size: 7,487 IPOs - A 2017 paper on IPO long-term performance analyzed this many U.S. IPOs. IPO underperformance horizon: up to 2 years after going public - The paper found statistically and economically meaningful underperformance over this period. Market beta of example funds: approximately 1.0 - Their factor review of the challenged funds found near-perfect market exposure. Skilled-manager statistical definition: 36 years with 2% alpha and 6% standard deviation of alpha - They cited this as the 95% confidence threshold for detecting skill. Home Buyers' Plan limit: $35,000 each - They noted the RRSP home-buying withdrawal limit per person. TFSA withdrawal room: restored the following year - They emphasized that TFSA withdrawals create room again the next year. Market-linked GIC commission: 4% to 5% - They said these products often pay banks large upfront commissions. Five-year market probability: about 70% positive - Used to argue that capping upside over a five-year term is usually a bad tradeoff.

Pivotal Quotes: "We’re going to take a break from talking about factors." — Benjamin Felix: Explaining the new episode structure and desire to reduce the podcast’s reputation as a “factor podcast.” "There’s a huge difference, huge difference between a good company and a good stock." — Benjamin Felix: In the discussion about why selecting “good” companies does not reliably produce good returns. "The reality is, using these is you’re being hamstrung by the upside cap." — Benjamin Felix: Critiquing market-linked GICs/structured notes and explaining the core investor tradeoff.

Implications: Listeners should be skeptical of active-management marketing, IPO hype, and structured products. For most Canadians, disciplined indexing plus thoughtful account placement and tax planning is likely superior to chasing stories or “protected” upside.