A few weeks ago, Canada's market for exchange traded products (ETPs) hit a new milestone: there are now more than 200 ETPs, worth almost $50 billion, listed on the Toronto Stock Exchange. Just two years ago, there were less than half as many ETPs listed on the Toronto Stock Exchange. And well over 90% of the ETPs listed on the exchange are exchange traded funds (ETFs). Clearly, this investment product has caught the interest of Canadian investors.
In 2009, we wanted to help investors understand ETFs, which were just starting to gain traction in Canada. So, we published an ETF primer. With this recent milestone hitting the market, we thought it would be a good time to point out four things you should know about ETFs.
photo credit: kenteegardin
1. ETFs are not the same as mutual funds
ETFs and mutual funds have some similarities. Both types of investments are made up of several underlying securities (stocks, bonds, or other assets). Many ETFs have similar investment mandates as many mutual funds, and both investment types typically track an index. But the similarities end there. While mutual funds are actively managed to beat whatever index they're tracking, an ETF mimics an index and aims to match its return. And ETFs, unlike mutual funds, are traded on a stock exchange.
2. Not all ETFs are passively managed
You often hear that ETFs are passively managed. Most are. They mimic a simple index by investing in the same securities in the same weights. And they match that index's return. However, some ETFs are more actively managed. Some use more complicated investment strategies to choose which securities in the index they want to invest in, and in what weights. Some ETFs don't hold securities directly, but rather gain exposure to securities using advanced investment strategies (derivatives like counterparty contracts or swaps). The goal of these more advanced strategies is to give the investor a better return.
3. Not all ETFs cost less than mutual funds
But again, many do. Passively managed ETFs should be low-cost. In fact, the management fees should be significantly lower than what you'd get with a mutual fund. (Vanguard Group, which recently announced its Canadian launch, offers ETFs in the United States with fees as low as 0.7%.) However, the more actively managed ETFs mentioned above will cost more, because the fund manager has to work harder to implement the fund's more complicated investment strategies. Keep in mind, though, that the higher fee may be worth it, because again, the goal is to give the investor a better return.
4. There are plenty of options
As we mentioned, there are now hundreds of ETFs trading on the Toronto Stock Exchange. You can find an ETF that follows a simple, broad-based index, or one that uses derivatives to improve its risk-adjusted return. You can find a lower-risk ETF that mimics a bond index, or one that invests entirely in precious metals. There are so many options, and to start investing, all you need is a broker account. If you need more information, check out our article on Canadian discount brokerages.
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