ETF evolution in Canada

People are always on the lookout for cheaper ways to invest. And for some Canadians, that’s meant turning to exchange-traded funds (ETFs), which have gained popularity in recent years as a cheaper alternative to mutual funds.

An ETF is a basket of stocks or bonds tracking a specific index – say the S&P 500 for stocks, and DEX Bond Index for bonds. Buyers are basically purchasing shares of a portfolio tracking the yield and returns of that index. The investment is essentially passive, since it mimics performance of the selected index.

And, since this investment structure means a computer can do a lot of the work, investors pay lower management fees and improve their returns through cost-management as opposed to portfolio upside. One firm estimates management expense ratios (the calculation used to determine how much it costs to run an investment product) averaged 0.81% for ETFs during the year ending December 2012, compared with 2.01% for mutual funds.

Cost attractiveness has spurred growth; ETF assets being managed by advisors rose 26.7% annually over the past five years, according to research firm Investor Economics, compared to a 10.7% growth rate for mutual funds during the same period.

As of December 2013, Canadian-listed ETFs reached $63.1 billion. That’s still small, though, compared with the $982 billion Canadians funneled into mutual funds last year.

Trading and pricing particulars

Unlike mutual funds, which disclose their portfolio holdings on a periodic basis, ETFs are required to reveal holdings daily. That, coupled with the fact they’re tracking an index, makes them very transparent. It’s easy to tell how much they’re worth day-to-day.

Investors can also buy or sell ETFs at any given time during market hours, since they’re traded on stock exchanges. This contrasts with mutual funds, which give buyers and sellers the price at the end of the trading day, since the prices of the all a fund’s holdings must be factored to determine the fund’s value. For efficiency sake, those calculations are done once a day.

But ETFs also are evolving beyond the passive, index tracking space.

More recent entrants to ETF markets are actively managed funds, in which assets are selected by managers with a stated goal of outperforming an index.

Time will tell how popular these offerings become. But industry observers note right now most Canadians remain conservative and concentrate most of their ETF assets in global-diversified, passively managed and long-only types of asset classes.