The first-ever ETF was actually launched in Canada in 1990. It tracked the performance of the 35 biggest stocks on the Toronto Stock Exchange by market cap. The ETF business didn’t take flight in the U.S. until three years later, and it hasn’t looked back since.
There were over 800 Canadian ETFs as of December 2020, managing C$257.3 billion of assets, up sharply from $56.4 billion eight years earlier. In the U.S., the industry had $5 trillion in assets under management as of November 2020.
ETFs at a glance
When discussing ETFs, a good place to start is by comparing them to mutual funds, which have been a staple of Canadian portfolios for decades.
Like mutual funds, ETFs hold a range of investments, including stocks and corporate and government bonds. But unlike mutual funds, which are priced at the end of each trading day, ETFs trade on stock exchanges, so they’re priced up to the second during the exchange’s operating hours—and you can buy and sell them, just like a stock.
Another difference: most ETFs aren’t run by a portfolio manager. Instead, their portfolios are set up to mimic an index, commodity price or other basket of investments. There are ETFs that track everything from small cap U.S. stocks to foreign stocks and even gold and copper prices (more on commodity ETFs in a moment).
There are also hedged ETFs that let you invest internationally without having to worry about your profits being eroded by currency fluctuations.
To get even more obscure, there are leveraged ETFs** that rise and fall at multiples of their underlying index. So a leveraged ETF that’s designed to, say, double the moves of the S&P 500 would give you twice the index’s gains on up days but also twice its losses on down days. You wouldn’t want to hold a fund like this in a crash like March 2020, for example.
Bottom line: it’s important for you to understand how your ETF is managed (or not), how they track, and how they are priced.
ETF fees are low, but management may be up to you
The first thing that comes to mind with ETFs is the lower fees than those of mutual funds. It’s not unusual to find ETFs with management expense ratios (MERs) of 0.2% of assets or less; the median MER for Canadian mutual funds, as of 2018, was 1.98%.
In addition to management fees, you pay trading fees when buying an ETF, as you would with a stock. But with ETFs you won’t have to pay the sales fees that can apply to mutual funds, namely a front-end load, which is charged at purchase; or a back-end load, which is charged if you sell your mutual fund within a set timeframe.
However, there’s more to comparing mutual fund and ETF fees than just stacking up their MERs. You’ll also want to look at past performance, and it pays to keep in mind that the charts you usually get from fund providers illustrate performance net of fees (though you will want to confirm this). And while past performance is not indicative of future performance, it does give an investor a good sense of how an investment reacts during different times in a market cycle.
So if a mutual fund is performing well even with fees included, paying for that manager’s skills may be a good investment on its own.
There are other reasons why paying for a manager can be a smart move, says BlueShore Wealth and Credential Securities Investment Advisor Graham Priest: “When you hire a portfolio manager or buy a mutual fund, the manager can help protect against losses by rotating into defensive sectors or going to cash. Most ETFs can’t do that.”
ETFs offer an easy way to diversify
ETFs can be a good low-fee way to target a specific part of the world. That’s because foreign-focused ETFs trade in North America, saving you the complication of buying stocks on unfamiliar foreign exchanges. And there are plenty of international ETFs out there, including those that target global stocks as a whole and those that focus on individual countries and regions.
ETFs can also target specific sectors such as tech, energy, health care, or finance.
ETFs can be useful for commodity investing
Similarly, you can also use ETFs to add to your portfolio’s commodity exposure. Priest, for example, recommends that investors interested in holding gold do so through an ETF.
“Getting gold exposure through an ETF saves you the cost of storing gold and the security worries of having gold bars or gold coins in your home,” he says. “It’s also more economical to sell a gold ETF. With physical gold, you’re at the mercy of what your local dealer is willing to pay, which might be different than gold’s actual market price.”
Commodity ETF options go well beyond gold: you can use these funds to invest in everything from natural gas to copper and even soybean futures.
ETFs as a tax strategy
Another strategy Priest suggests is using ETFs when selling other securities at a loss for tax purposes.
Let’s say you want to sell a stock from a non-registered account (i.e., not your TFSA, RRSP or RESP) and it’s below your purchase price. A sale would let you claim a capital loss when you file your taxes.
Under the superficial loss rule, you can’t buy the same stock within 30 days before or after your sale, and if you do, you can’t continue to hold it past that 30-day limit. If you do, you won’t be able to claim the loss, and the Canada Revenue Agency will instead add the value of the loss to the price at which you rebought the stock.
In such a situation, Priest says, you could roll the money from the sale into an equity-focused ETF and then, if you wish, sell the ETF and repurchase the stock you sold after the 30-day time limit expires. That would keep the funds in the market, potentially diversify them further and perhaps even give you exposure to the same stock you sold, if it’s also held by the ETF you purchase.
ETFs and the broader market
Finally, you may remember a story from a few years ago in which Michael Burry, who made a fortune betting against the U.S. housing market in 2008 (as portrayed in the film The Big Short), warned that the popularity of ETFs would cause a market crash.
The fear is that as more money is invested in ETFs, these funds buy more of the securities in their portfolios, driving those firms’ share prices higher, eventually leading to a stock-market bubble—and then a sharp correction.
Is this a valid concern? Priest feels that as with most things in investing, it’s important to take a long-term view: “Trading activity of any large fund would impact the price of the securities traded,” he says. “And that could cause a price drift from levels that are supported by the underlying business. This can have a short-term impact, but in an efficient market, prices will return to levels supported by fundamentals.”
Your advisor can help
There are numerous advantages to ETFs, but they can be a complex investment vehicle. In addition to what we’ve discussed above, there are closed fund ETFs vs standard, and liquidity may be an issue with some.
Your advisor can help you build ETFs into your portfolio that is right for your goals, timeline and risk tolerance.
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