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exchange-traded funds

Mark Raes, head of product with BMO Asset Management in Toronto.Matthew Sherwood/The Globe and Mail

Acres of forest have been sacrificed in recent years to communicate the idea that mutual fund fees charged to Canadian investors are high compared with those in other countries. Management expense ratios (MER) that average about two per cent annually can be a significant drag on investors' returns.

So what can the average investor do about it? Plenty, it turns out.

The proliferation of low-fee exchange-traded funds (ETFs), and more recently the introduction of a series of funds that utilize sophisticated investment strategies that go well beyond simple index holdings, has meant that just about any investor can construct a portfolio made up entirely of the low-cost funds.

That is not just the opinion of some ETF proponent but rather that of an executive with one of the country's big five banks.

"Absolutely, that in fact is becoming a very popular investment decision not just for individuals but for some fee-based advisers," said Mark Raes, head of product with BMO Asset Management, based in Toronto.

"Because the universe of available investments in ETFs has grown so much, so dramatically, it has given investors the full spectrum of investment classes or investment styles that maybe they didn't have in years past," Mr. Raes said.

An example of how ETFs are becoming more tailored to specific investor needs can be seen in BMO's successful S&P/TSX Laddered Preferred Share Index ETF (ZPR), which has grown to $618-million since its launch in November.

"Anyone who does any kind of laddering strategy, whether it be bonds or preferred shares, now there are ETFs available that offer that same solution with a one-ticket buy where the owner doesn't have that ongoing maintenance of the portfolio," he said.

About 270 ETFs are available to Canadians, and investors in the United States could pick from nearly 1,200 as of last November, according to the Investment Company Institute.

While the Bank of Montreal has not abandoned the traditional mutual fund in any way, it is unique among its big bank competitors for its wholehearted embrace of ETFs. It offers 55 funds, a figure that Mr. Raes had to carefully double check given the fact that the bank has recently introduced seven new ones.

Many investors are buying ETFs to replace individual securities and mutual funds in an effort to reduce the volatility of their portfolios and keep costs down, Mr. Raes noted.

As markets increasingly are affected positively and negatively by global events, "it has become less of a stock picker's market and more of an asset allocator's market," which is another point in favour of ETFs, he added. The low-cost funds give investors broader exposure.

So how do you build a portfolio using ETFs? Tyler Mordy, director of research and co-chief investment officer of Hahn Investment Stewards of Toronto, recommends that investors start with "core, solid, stable building block" ETFs that offer broad-based exposure to cash, stocks and bonds that are the "purest beta," in other words those that are the lowest-cost, most tax-efficient and most liquid.

Most Canadians are heavily overexposed to resource and financial stocks. "Canadian investors are so overexposed to domestic assets right now, it is not even funny," Mr. Mordy said. That worked well during the commodity boom but looks less wise given slow-growth forecasts for Canada.

For Mr. Mordy, the beauty of ETFs is they can allow investors to add "bread and butter" holdings such as international stocks or emerging market securities at transaction costs undreamed of a few decades ago. Or they can embrace sophisticated strategies that allow investors to go overweight in industry sectors or regions that are poised to outperform.

Investors have been able to build a diversified portfolio solely using ETFs for about a decade, even though that idea is really just catching on now, said.

"Our firm pegs June, 2003, as the actual official date when we could build a truly globally diversified portfolio exclusively with ETFs," he said. "That is kind of how we built our firm. Our founder, Wilf Hahn, has said that you can build a better $100,000 portfolio today than you could for a $10-million pension plan back in the 1990s."

He disputes the commonly held belief that ETF-based investing is passive, however. "As soon as you have made a financial planning decision or an asset mix decision you are introducing an active component to the investing world," he said. "Unless you can buy the entire world capital markets, then you are an active investor."

Market re-entry

To check the popularity of exchange-traded funds with investors one can simply follow the money. In March, $1.9-billion flowed into Canadian-listed ETFs, the highest monthly tally in more than two years, noted Mary Anne Wiley, above, managing director and head of iShares Canada in Toronto. "As investors are getting back in the market, more and more they are opting to do so using ETFs."

Ms. Wiley chalks it up to their efficiency and ability to provide diversified exposure to a segment of the market, and their low-cost format.

Today's low-return, low-interest-rate environment has also made investors more sensitive to investment costs, which puts ETFs in an even better light, she argued. "If the markets are going to give you single-digit returns, as most expect these days, then keeping your cost down is an effective way to get your overall return up," she said.

The average MER for mutual funds is 2.31 per cent in Canada, compared with an average for ETFs of just 0.41 per cent, she noted. So a typical ETF investor needs to generate less in annual returns to simply stay ahead of inflation, which the Bank of Canada attempts to keep between 1 and 3 per cent annually.

The original newspaper version of this article and an earlier online version incorrectly stated how many ETFs the Bank of Montreal offers. This online version has been corrected.