When King Midas, aka Warren Buffett, aka the Oracle of Omaha, mentioned his liking for a rather bland exchange-traded fund this year, the investment community jumped.
In a letter to shareholders of his Berkshire Hathaway holding company, Mr. Buffett, 83, reportedly said that he has advised in his will that 90 per cent of his cash be put in "a very low-cost" index fund which simply tracks the movement of the S&P 500. (He named a fund in the Vanguard family of ETF funds.)
Could there ever be a better advertisement for index or exchange-traded funds? Maybe it's time to look at them again, those lesser-known younger siblings of mutual funds.
Canadian investors love mutual funds. Canadian mutual-fund holdings have reached $1.11-trillion, as of July 31, according to the Investment Funds Institute of Canada. This is more, to say the least, than the mere $70.1-billion in Canadian ETF assets by June this year, reported by the Canadian ETF Association (CETFA). CETFA was created two and a half years ago, mainly because the ETF community didn't feel sufficiently represented by IFIC and other investment organizations.
Pat Dunwoody, executive director of CETFA, sees the continuous preponderance of mutual funds over ETFs stemming from the certain uniqueness of Canadian investing compared with that in the United States.
Canadian investors generally buy what their money managers offer them, Ms. Dunwoody argues. In turn, many advisers' compensation is largely based on trailer fees and commissions for selling mutual funds, so there is an incentive to sell mutual funds.
"ETFs are already in an awkward position. There are a few that offer trailer fees [to investment advisers]," she says. But those fees and commissions aren't enough to sway advisers to ETFs. The whole selling point is that they are more cost-efficient for investors.
So, to help gain more traction for ETFs, the CETFA is among those supporting the move in Canada toward greater transparency of commissions and fees and promoting the model in which some advisers don't rely on commissions but simply on charging clients for advice. This kind of structural change would help ETFs.
Meanwhile, as interest continues to build, others besides Mr. Buffett are praising ETFs. "They are an incredibly valuable tool for an individual investor. People are more familiar with them now, [but] you can still get into trouble with them, if you don't know what you're doing," says Nancy Graham, portfolio manager in the Ottawa office of PWL Wealth Management.
Ms. Graham is paid by her clients, not through commissions, so she's the type of financial adviser the CETFA likes. However, she warns against ETFs that are too specialized in a certain group of assets and not diversified enough. There are many new ETFs which, rather than following an overall index such as the S&P 500, follow just companies with a certain market weighting or some other subset of an index.
Those "are just capital destructive in our opinion," she argues. Instead, she likes ETFs that track the broader market and characterizes those as a very efficient, cost-effective way to get broad market exposure.
There are also a number of ways in which ETFs are traded which give them a tax advantage. As Ms. Dunwoody explains, mutual fund managers continually have to sell securities as shareholders redeem their holdings and to reallocate assets. These sales within the mutual fund portfolio create capital gains, Ms. Dunwoody says, "even for shareholders who may have an unrealized loss on the overall mutual fund investment." ETFs are able to avoid this with a more simple tax structure.
Generally speaking, the only capital gains or losses that a client would incur are the difference between what they bought it for and what they sold it for, Ms. Dunwoody says, adding that this makes ETFs more tax efficient.
Still, underlying the sales pitch are ETFs' lower costs.
"To be honest, I don't think we are as fee conscious as the U.S. I think that's changing. But when you look at the fee battles that have gone on in the United States both for mutual funds and other products, we haven't had that up here," Ms. Dunwoody says.