Pension investing with ETFs

December 1, 2011 | Last updated on September 21, 2023
10 min read

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Joe and Sally joined the same company right out of school and enrolled in the registered group savings plan. Sally was three months older than Joe and retired September 1, 2008 with a $600,000 portfolio. Joe’s portfolio was worth only $480,000 when he received his simulated gold watch a few months later. Had they been members of a defined benefit (DB) pension plan—DB plans determine a pension usually based on a percentage of salary, with the benefit being the employer’s obligation—Joe and Sally would be drawing identical pensions, all things being equal. They made identical contributions—with identical employer matches—to buy identical funds in the identical proportion for forty years. The difference in outcomes because of something as uncontrollable as a birth date seems incredibly unfair. Something is wrong here.

DC plans and RSPs are different than DB plans

DC and RSP benefits are completely a function of contributions and the actual investment result for each employee. Employees are responsible for the outcome, not employers, and the pension amount is unknown until retirement. High costs, poor investment decision-making and lack of scale are documented problems with DC plans, which have generally experienced returns 1% lower than DB plans over time, according to a recent Towers Watson study.

Investing time horizon

DB plans need to match long duration liabilities to pay pensions of existing and future workers, so they usually invest with a very long-term view. Mutual funds, following the objectives in their prospectuses, similarly invest with a long-term view and often a perpetual duration. As a result, establishing and rebalancing portfolios to a fixed asset allocation is popular with DB plans because short-term market variability is theoretically evened out over time. Perpetually long investing horizons always have time to make back losses. In reality, Sally, Joe and every RSP and capital accumulation plan investor has an investing time horizon that is shrinking and shortening everyday, whether due to retirement or death. Constructing a portfolio that does not recognize this fact is at best irresponsible, and at worst negligent. Yet most advisors, registered reps and educational sessions for DC plans promote the same basic strategies that were designed for DB plans: diversify, buy, hold and rebalance. The exception is the “target date fund” that automatically reduces equity exposure over time on a fixed glide path. Early generations of this increasingly popular approach have not escaped controversy, a subject we will examine in Part II.

ETF investing options

Symbol ETF MER
CLF Claymore 1-5 Yr Laddered Government Bond ETF 0.15
ZFS BMO Short Federal Bond Index ETF 0.20
ZFM BMO Mid Federal Bond Index ETF 0.20
ZFL BMO Long Federal Bond Index ETF 0.20
ZPS BMO Short Provincial Bond Index ETF 0.25
CMR Claymore Premium Money Market ETF 0.25
CBO Claymore 1-5 Yr Laddered Corporate Bond ETF 0.25
ZRR BMO Real Return Bond Index ETF 0.25
XSB iShares DEX Short Term Bond Index Fund 0.28
ZAG BMO Aggregate Bond Index ETF 0.28
CAB Claymore Advantaged Canadian Bond ETF 0.28
ZCS BMO Short Corporate Bond Index ETF 0.30
ZCM BMO Mid Corporate Bond Index ETF 0.30
ZLC BMO Long Corporate Bond Index ETF 0.30
XBB iShares DEX Universe Bond Index Fund 0.33
XRB iShares DEX Real Return Bond Index Fund 0.39
XLB iShares DEX Long Term Bond Index Fund 0.39
XGB iShares DEX All Government Bond Index Fund 0.39

Source: PUR Investing Inc.

Conclusion 1:

DB plans invest to match perpetually long-dated liabilities, while DC and RSP investors have investing horizons that are shrinking every day. By building portfolios that have fixed asset mixes without regard for the individual requirements of each investor, the industry is ignoring what investors need. Trimming risk from a portfolio as retirement approaches is one effective tactic. A simple way to do this is to introduce ETFs to build in an increasing proportion of stable, low risk. Here are some low-risk choices that can be introduced at least five years before retirement, ranked by cost.

Conclusion 2:

If returns are 1% below DB plans, using passive or indexed vehicles can help make up the difference. ETFs are appropriate to use if RSP contributions are made once a year. If deposits are made more frequently, as they often are with DC plans, the commission cost of buying ETFs may be prohibitive despite their low fees. Buying index mutual funds and making a transfer at the end of each year to one or two ETFs is the most cost effective approach. Claymore offers a commission-free way to buy their ETFs through certain brokers, an option worth exploring for some investors.


Joe and Sally have been abandoned by their employers and the investment industry. They make poor investment choices because they lack the time, inclination and expertise to make better ones. The pension industry—from portfolio managers, insurance companies and mutual fund companies to registered reps and employers—guides investors to build portfolios that mimic institutional DB mandates with time horizons ill-suited to the needs of individuals. The high cost of investing has robbed investors of at least 1% annually. ETFs can provide part of the answer, but they aren’t being used in Canadian DC plans at all. Cutting risk from portfolios at the appropriate time can help preserve capital, but investors still don’t get the reliable retirement income they want. We will explore alternative pension approaches that use ETFs in the future.

Part II:

Building target-date funds with ETFs

Target-date or lifecycle funds (TDFs) simplify investing by automatically reducing equity exposure as a target retirement date or a student’s anticipated university enrollment approaches. TDFs are the hottest segment of a rapidly growing defined-contribution (DC) pension market, which includes RSPs.

Eighty percent of DC plans in the U.S. and U.K. offer TDFs with global uptake increasing rapidly. Impressively, two-thirds of all new money in U.S. DC plans is flowing into TDFs. In Canada, most DC plans looking to add choices have TDFs on their wish lists, according to Mercer.

Registered representatives (RRs) should pay attention. TDFs challenge the RR’s traditional role of managing asset allocation, and they do it reasonably well. The appeal of TDFs is that no asset mix decisions are required by investors who generally lack the knowledge, time or inclination to make them. It’s no surprise investors embrace these one-decision products in capital accumulations plans. If product manufacturers get their act together, retail investors could learn to love them, leaving many RRs underemployed.

TDF principles

The principles of TDFs are as follows:

  • Broad diversification
  • Reduce equity exposure to or through the targeted date
  • Low cost

My colleagues and I have examined TDFs extensively. There are three types: TDF 1.0: basic; TDF 2.0: conservative, moderate, and aggressive for each target date; and TDF 3.0: a proprietary goals based version that addresses what pension investors really want—a no-hassle personal solution that increases the probability of a reliable income in retirement. (For more, see my article, “Target Date Funds 3.0” on

Fixed glide path

TDF 1.0 and 2.0 feature fixed glide paths that systematically reduce equity exposure to or through a target date. Many TDFs got into trouble between 2008 and 2009 by holding too much in equities (50% to 60%) for near-dated (2010) funds, losing 25%-30% of their value within a year. The chart “Fixed Glide Path” (below) illustrates a typical fixed-asset-allocation glide path with target dates shown at the bottom. This one, derived from iShares U.S. Target Date Series with MERs between 0.29%-0.31%, holds exclusively iShares ETFs.

Fixed Glide Path Chart

Investors could buy or replicate these U.S.-based ETFs, but currency becomes an issue for Canadians who retire spending Canadian dollars

Wrong assumption

We think TDF 1.0, a first-generation approach, is sub-optimal. It uses a fixed glide path that assumes market volatility stays pretty much constant. Witnesses of market meltdowns in 1987, 2000-2001, or 2008-2009 know this assumption is wrong. Furthermore, TDF 1.0 lacks the flexibility to accommodate personal risk preferences or actual cumulative investment results. Nevertheless, RRs need to offer something at least as competitive. Disciplined asset mix shifts are one aspect of TDFs that beat most RR-based models and wrap accounts that have naïve buy-hold-rebalance strategies.

TDF 1.0 example

2040 2030 2020 RETIRE MER SYMBOL
Claymore Balanced Growth Core Portfolio 100% 90% 70% 50% 0.82% CBN
BMO 2025 Corporate Bond 10% 10% 10% 0.30% ZXD
BMO 2020 Corporate Bond 10% 20% 0.30% ZXC
Claymore 1-5 Laddered Corporate 10% 10% 0.25% CBO
Claymore 1-5 Laddered Government 10% 0.15% CLF
BMO Monthly Income 0.55% ZMI
Claymore Canadian Financial Monthly Income 0.65% FIE
iShares Diversified Monthly Income 0.55% XTR
iShares Growth Core Portfolio Builder 0.60% XGR

Source: PUR Investing Inc.

Cost is a key driver for portfolio construction. The chart above, “TDF 1.0 example,” is a partially hedged example of TDF 1.0 replication for clients with modest portfolios.

TDF 1.0 for portfolios under $50,000

Simplicity is the key for these investors. My colleague Ioulia Tretiakova, director of Quantitative Strategies at PUR Investing, rightly points out that “getting the broadest diversification for the money should be a primary goal.” She explains, “Investors and advisors who lack the tools to maintain consistent volatility in their portfolios (a feature of TDF 3.0) could use, as a core holding, Claymore’s Balanced Growth Core-Portfolio (CBN) that includes some BRIC (Brazil/Russia/India/China) and gold exposure with a 17.4% fixed income weight. The iShares Growth Core Portfolio Builder (XGR) offers better diversification at a lower fee (0.60% vs. 0.82% for CBN) but with 60% equities and 40% bonds, it’s too conservative for long-dated TDFs.” In Part III, we will illustrate how XGR can be combined with other ETFs for more sophisticated TDFs.

Some investors retire at the wrong time—when markets are weak. It would be prudent to cashmatch needs about five years before funds are needed—for an annuity or to pay for college, for example. Zero-coupon bonds are ideal, but availability can be an issue. BMO’s Corporate Bond Target Maturity series helps. Adding these ETFs both pre- and post-retirement is a good way to preserve capital and match cash needs. Income ETFs can be added post-retirement to generate regularly distributed cash.

In the next part we will consider more sophisticated portfolios that incorporate inflation protection, and suggest ways to control volatility and adjust for actual investment returns.

Part III:

When Harry met Sally’s portfolio

In the now-iconic scene set in Katz’s Delicatessen in New York City, a woman of some years mischievously asks her waiter to bring her the rye and pastrami sandwich she assumes was responsible for Meg Ryan’s character Sally’s headturning display of euphoria. Portfolio envy is a lesser known form of a similar syndrome.

In pension terms, Sally has a defined benefit (DB) portfolio. Harry has a defined contribution (DC) plan, but overestimates his ability to distinguish real money management from fake management.

DB plans provide members with reliable income in retirement and are managed by professionals. DC plans, including RSPs, are managed by reluctant plan members from a bewildering array of mutual funds not designed for DC pensions. No wonder people want what Sally is having. Professionals have not done that well with DB plans, either. Plans were only 73% funded at the end of 2010 in Canada, according to Mercer. One-hundred percent funding means they can meet their obligations.

Investment professionals are not solely to blame. Employees and unions push for better benefits, asset managers lobby for more equities —which bring them higher fees—and employers take more risk in the hope that higher returns will lead to contribution holidays. In the financial crisis, inadequate risk controls penalized even the best DB plans.

Building the fool-proof deli portfolio

Daily VIX Graph, 1997-2010, Good Times to Hide Highlighted

Exchange traded funds (ETFs) give individuals and their advisors the tools to build sophisticated portfolios. Maintaining appropriate risk and reducing volatility as a target date approaches are the flavourful rye bread and richly smoked pastrami of retirement solutions.

Maintaining consistent risk can save investors a bundle. The table “Daily VIX”(right)—the implied volatility of S&P 500 options—is a readily available proxy for risk. Levels higher than 20 were good times to become cautious—1997 to 1998 and 2007. Levels above 30 were good times to hide (1999 and 2008). Conversely, periods of stable or declining VIX—levels under 20— would have been good times to own stocks.

Ioulia Tretiakova, Director of Quantitative Strategies at PUR offers this example using a hypothetical portfolio consisting of iShares’ S&P TSX Capped Composite Index Fund (XIC) and iShares DEX Universe Bond Index (XBB). If VIX is under 20, the portfolio shifts to 100% XIC. If VIX is between 20 and 30, the asset mix is 50% XIC and 50% XBB. If VIX is over 30, the portfolio shifts to 100% XBB.

Results from running this hypothetical strategy from February 2001 to April 2011 are found in Table B (below).

Table A

VIX LEVELS 100% STOCKS 80/20 60/40 50/50
Mix A Mix B Mix C Mix D
Under 20 100% / 0% 80% / 20% 60% / 40% 50% / 50%
20 to 30 50% / 50% 40% / 60% 30% / 70% 25% / 75%
Over 30 10% / 90% 8% / 92% 6% / 94% 5% / 95%

Results from running this hypothetical strategy from February 2001 to April 2011 are found in Table B.

Table B

Return 10.4% 7.3% 5.4% Mix D
Risk 9.8% 18.4% 10.1% XIC/XBB

The strategy improved the return not only of the all-equity portfolio, as expected, but also of a diversified 60/40 balanced portfolio while maintaining similar risk.

Most investors would find a portfolio that moved from 100% stocks to 100% bonds too active. An alternative is to apply the same rules to the equity portion of a portfolio. Table A (above) shows corresponding equity weights for balanced portfolios at 80/20, 60/40, and 50/50. We believe wider asset allocation shifts than those many investors have become accustomed to are the future of investing in volatile markets. This suggests a more active role for knowledgeable advisors and registered reps.

Chart 2-Mustard, a dynamic glide path and Chart 3-Different portfolios with declining equity exposure as target date approaches

Today’s target date mutual funds are fundamentally flawed. All have static glide paths that reduce equity exposure as the target date approaches. It sounds like the portfolio’s risk is reduced over time, but risk is not static. Equity risk can change dramatically over a working lifetime so that 60% equity means something very different at the peak of the technology boom than at the bottom of the financial crisis in 2009. The remedy is to manage a portfolio to declining risk over time.

Examples are based on daily VIX but a monthly approach would also be beneficial. PUR will post updated risk data monthly on its website ( for those interested in following along.

The pickle

A kosher dill is essential to finishing off the dish. In a similar way, diversification will help to dampen risk further. Our simple stock-and bond model is a guideline only.

This approach is theoretically better than anything available today for DC plan investors. Maybe both Harry and Sally will want what YOU are having!