TIPs/HIPs vs Index Funds - I

gk, I'm not exactly new to investing, but not necessarily any wiser. As I understand it, the two are "the same only different" as we used to say. TIPs are a derivative based on the performance of the Toronto Stock Exchange 35 Index which includes the 35 largest companies traded on the TSE (the Canadian equivalent to the Dow Jones Industrial Average in the USA). They are bought and sold on the stock exchange as with company shares. They pay a dividend, and their daily value reflects the movement of the TSE35 Index. Index funds are put together by certain fund companies and are a special type of equity (stock) mutual fund. Their holdings should replicate the weightings of s particular Stock Market Index, and their net asset values should track changes of this index. They are guaranteed to perform exactly as the market does, never doing better, never doing worse. If this explanation is wrong, someone will correct it, for there are many knowledable contributors to these threads.

rge..... I would agree with what you say with one notable exeption... Index funds will always do worse than the index because of the ever-present MER fees. You buy TIPS and you pay a commision once on your purchase. OTOH if you buy an index fund you will lose a certain % year after year in the form of management expenses. These fees guarantee you have to do worse than the index itself. Hope I helped....

From what I understand, TIPS also withhold a certain part of the dividends from the 35 stocks to cover administrative fees or somesuch.

Regards, Ted

Thanks James and Ted for the update and for rounding out my explanation. gk may also be interested in HIPs, which are based on the TSE100 Index, i.e. the largest 100 of the 300 stocks in the TSE300 (the basic index used to track the performance of the Toronto Stock Exchange). Based on 100 stocks rather than 35, they would more closely parallel a true ind4ex fund. James and Ted, agree?

Thanks for the info guys. One more question. Does one have to have a self-directed RSP to buy HIPS or TIPS? I presume the mutual fund types wouldn't matter. Thanks gk

gk

Is there capital gain or even year-end distributions in TIPS? What happens to the unit value if the component of TIPS changed (i.e. a couple of companies are replaced by others)?

One minor point above has been made that TIPS withholds a potion of the div distributions - I do believe everything is paid through to the unitholder, the "time value" of the cash flow from the divs is all that pays for the MER of TIPS.

You should also be aware that there are very good TIPS-like products available on other exchanges (like SPDRS on the S&P 500 in the US). I think the Financial Post has had a few good articles on these products - you might look in their archives available through www.canoe.ca

Yes, generally a SD RRSP is needed for these products.

As always, consult an approriate advisor to ensure that these securities are suitable to your investment psychology and style and to ensure that your asset mix is correct. THE ABOVE COMMENTS ARE NOT TO BE CONSTRUED AS A RECOMMENDATION FOR OR AGAINST THE SECURITIES MENTIONED.

Warren.

TIPS are actually not derivatives.TIPS are units of a trust created by the TSE.The underlying assets of the trust are shares of the 35 constituent companies which make up the TSE35 Index from time to time.These shares are held by the trust in the same proportion as they are reflected in the Index.

There are only a handful of Canadian stock index funds available, and the average MER is quite high (just under 2% by my calculations). It's bad enough when active management comes at an average 2.3%, but it's oviously expensive to run a fund because for no management it's costing almost 200 bps! This reinforces the value of Vanguard who charges something like 0.2% for their index funds. For Canada, stick with the TIPS and the HIPS.

Rick, thank you for that clarification of what TIPS are. But this begs further questions: How many shares of the 35 companies in the TSE35 does the trust hold? And is it open-ended, i.e. when new money is invested does it buy more shares of the 35 companies? And when you but a TIPs share, what the hell are you buying???

Go to http://www.independentfinancial.on.ca/archives.htm#Index Funds

This topic has been done. Links to the explanations of TIPS etc. are there.

Warren, what's with the disclaimer. Company told you to do so, or the lawyers?

Regards,

Jay

Re: the hyperlink: I guess I couldn't. Bylo?

STill need explanation for my previous question. If I buy TIPS at $36. In Jan\Feb, if Royal Bank is removed from TIPS and replaced by , say, First Marathon. Royal is at $75 while FM is $20. Would the price of TIPs be dropped because of the replacement ?

rge,

Nice try, but not quite a cigar. Here's what you wanted to say:

rge, I know this is off topic, but prepare thyself for assimilation by Bill's Borgs:

Microsoft Acquires Hotmail
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rge and Bylo,by these definitions all mutual funds are derivatives.What a surprise to many!

Rick, I think the situation with a mutual fund is that the fund actually OWNS the securities which make them up, and the unit holder therefore is a part-owner (to be sure an extremely tiny part) of all the securities. For that rrason I would not consider them a derivative. With TIPs, I continue to ask, is there a fund or trust account somewhere that actually holds enough shares of these companies in the TSE35 so that each unit holder is actually buying a part. It is not unusual for a million TIPs shares to be traded in a single day. That would be one hell of a big fund assuming that only a fraction of all TIPs shares would be traded on any given day. I still am not sure that TIPs is anything more than a bet that the TSE35 will go up--in other words a type of option. Correct me if I'm wrong--which I'm sure you will.

Bylo, thanks for the info on . It was too good to last, wasn't it!

"With TIPs, I continue to ask, is there a fund or trust account somewhere that actually holds enough shares of these companies in the TSE35 so that each unit holder is actually buying a part."

Bylo, a very Happy and Prosperous New Year to you (and to everyone else rreading this message). But Bylo, are you telling me that the TSE has created a trust in which it has deposited a few million shares of each of the companies comprising the TSE35, or is this some sort of a virtual fund that exists only in the memory chips of the TSE computer? If the former, who is the trustee? If the latter, would this not make TIPs a derivative in the truest sense?

Bylo, Re: Big Bill Gobbles up Hotmail. No doubt you read the Hotmail president's six reasons why he is joining up with Big Bill. It seem to me he forgot to include reason 7: He recieved a gazillion dollars to sell out!

"the TSE has created a trust in which it has deposited a few million shares of each of the companies comprising the TSE35"?

Yup, that's my interpretation. My New Year's resolution is to contact the TSE and find out fer sure.

Anyway, back to Bogle on CNBC (11am-noon today).

rge,

The prospectus was a fairly straightforward read. Some interesting snippets:

"Toronto 35 Index Participation Units ("TIPS 35s") are units of a trust, the Toronto 35 Index Participation Fund (the "trust"), created by the Exchange. The underlying assets of the trust are shares of the 35 Constituent Companies which make up the Toronto 35 Index from time to time, held by the trust in the same proportion as these shares are reflected in the Index."

"Effective January 1, 1998, the trustee of the trust and custodian of the assets of the trust will be State Street Trust Company Canada."

"... the maximum number of TIPS 35s outstanding at any time will be limited by the requirement of the Exchange that the shares of any Constituent Company held by the trust not constitute 10% or more of the outstanding shares of the Constituent Company.

As at December 1, 1997, 87,748,867 TIPS 35s were outstanding." [rge, that's a tad more than what you characterised as "a few million"!]

"The Exchange has appointed a Discretions Committee to instruct the trust how to vote shares of Constituent Companies ... The Discretions Committee will also instruct the trust with respect to takeover bids, mergers and other matters requiring a decision by the trust as owner of the shares."

"Revenues earned by the trust from securities lending will be used to pay expenses of the trust, and the balance, if any, will be distributed to unitholders."

"There are no investment management fees payable by the trust.

The trust will invest the proceeds of dividends and other distributions (other than Special Dividends) on shares of Constituent Companies in a separate account in cash equivalent investments and the income from this account will be used to pay expenses of the trust."

Wife: "so hon, what were you doing in the basement on a Friday night?"

Bylo: "reading trust prospectuses"

Wife: "well at least you weren't surfing on the web again..."

Bylo, again you are to be commended for your thorough research (but mildly chastised for deceiving the missus, although it was for a good cause!). If there are 87,748,867 TIPS 35s shares outstanding, and each TIPs share represents one-tenth of the value of the TIPs Index, then there are some 8.7... million shares of the 35 companies, presumably distributed in the same ratio as with the makeup of the Index. So the TIPs is nothing more than one damn big mutual fund. I don't know if I am reassured or not by that revelation.