The popularity of exchange-traded funds (ETFs) has prompted the financial industry to create new ETFs that broaden opportunities for investors—and create new profit opportunities for the companies that sponsor them. They aim to mimic narrower indices than traditional ETFs and offer higher-risk strategies. In response to a question from a Member of his Inner Circle, Pat McKeough examines one of the newer ETFs, Purpose Core Dividend Fund ETF. The fund holds many high-quality companies. However, Pat takes a critical look at several aspects of the fund, including a rebalancing strategy that could prove costly for investors.

Purpose Core Dividend Fund ETF (symbol PDF on Toronto; www.purposeinvest.com) holds U.S. and Canadian stocks its managers see as being able to sustain and grow their dividends. The ETF yields 3.7%.

The fund holds mostly high-quality companies. They include AbbVie LyondellBasell industries, Pembina Pipeline, Finning International, Inter Pipeline, Ford Motor, Las Vegas Sands Corp., Bank of Nova Scotia, General Motors and National Bank.

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The Purpose Core Dividend Fund ETF holds 51.2% of its funds in Canadian stocks, 47.1% in U.S. stocks and 1.6% in cash. Its breakdown by industry is as follows: Financials, 15.1%; Utilities, 14.2%; Energy, 13.9%; Real Estate, 12.2%; Consumer Discretionary, 11.4%; Telecom Services, 10.0%, Industrials, 7.6%; Consumer Staples, 4.9%; Materials, 3.0%; and Information Technology, 2.7%.

Expenses on the units are 0.55% of assets.

ETFs: Rebalancing will cut your returns

The fund’s portfolio is equally weighted among the 40 stocks it holds. In general, we think you should stay away from equal-weight funds. In addition to incurring periodic charges to rebalance their holdings, they can cut your return by reducing the contribution from top performers if they soar to make up more than the capped limit.

“Traditional” ETFs practice “passive” fund management, in contrast to the “active” management that conventional mutual funds provide at much higher cost. These ETFs passively follow the lead of whoever sponsors the index. Sponsors of stock indexes do from time to time change the stocks that make up the index, however, and they do tinker with the rules for calculating the index. ETFs then change their portfolio holdings  to reflect these changes, without considering any impact the changes may have on the performance of the ETF portfolio.

On the other hand, some “new” ETFs use a conventional stock-market index as a base, but add their own refinements. This refinement usually aims to appeal to current investor trends or “hot” investment themes. It distinguishes the new ETFs from the older, plain-vanilla varieties that simply aim to mimic the index. It may attract attention in a crowded ETF field. If nothing else, it will justify a higher fee than the rock-bottom MERs associated with traditional ETFs.

In some cases, the new ETF improvement may provide an investment benefit, but it won’t do so consistently. Or it may hurt results, in the long run if not in the short. The worst cases are bad enough to turn investor profits into losses.

We see the Purpose Core Dividend Fund ETF, with its rebalancing feature, as an example of a “new” ETF.

We don’t recommend the Purpose Core Dividend Fund ETF.

Inner Circle recommendation: SELL

For more on our view on why few of the newer, higher-fee ETFs are worth holding, read  How to new ETFs compare with older-style ETFs.