For many investors, ETFs have gained popularity as a low-cost side investment
For many investors, exchange-traded funds (ETFs) have gained popularity as a low-cost investment side dish, a way to add some country, region or industry-specific spice to their portfolio. But given the profusion of ETF products now available to Canadians today, investors now have the option to make these cost-effective investments more of a main course.
"A great, efficient, low-cost portfolio can absolutely be crafted using ETFs," says Pat Chiefalo, managing director and head of iShares Canadian products at BlackRock Asset Management Canada Limited.
For investors interested in building a core portfolio out of the funds, they can start the same way that they would if they were building their investment holdings through more traditional vehicles such as equities, mutual funds or fixed income investments.
"Portfolio building should start with, and depend on, the risk profile of the investor," he says. "That generally comes down to asset allocation between equities and bonds. That is going to be the key driver of the overall risk of the portfolio and the overall return of the portfolio."
To use a simplified example, a more aggressive investor would tend to favour a mix that tilts more heavily to stocks, while someone with a conservative bent would likely hold a higher percentage of fixed income investments (like bonds).
Beyond the initial asset mix decision tied to your personal risk profile, Mr. Chiefalo says that investors should take advantage of the wide range of available ETFs to create a portfolio that is well diversified. "You want to make sure that the portfolio that you are taking on is well diversified across geography, across sectors and across asset classes."
He suggests that investors create a "good core foundation" by shopping for funds that are not just low-cost, but that also offer strong performance relative to the benchmarks that they track.
"You can think about Canadian equities, U.S. equities, international equities, as well as domestic and international fixed income and assemble your portfolio that way, using ETF building blocks," says Mr. Chiefalo.
This approach can help investors move away from the "hometown bias" that many Canadians have by holding a disproportionate amount of domestic equities in their portfolio. Being overexposed to Canada's resource-heavy markets paid off for investors in the so-called commodity supercycle that was a result of a China-led developing economy surge, but now Canada is facing the inevitable hangover as that boom turns to bust.
"You are going to have [a hometown bias] in every market," says Mr. Chiefalo. "But in Canada you need to be careful with that bias simply because we have a very concentrated market and that is going to lead to concentrated risk. That is why it is exceptionally important for Canadians to make sure that their portfolio is globally diversified to lose that sector concentration."
Geographic diversity is easy to accomplish with ETFs, says Mr. Chiefalo. "You can essentially capture the Canadian market with one ETF, the same with the U.S. and international equities.
"With three ETFs you have effectively replicated a global equity portfolio, which previously was a lot harder to do without these products," he says.
With more than 300 ETFs in Canada and over 1500 in the U.S., investors' strategies can range from the very simple "three ETFs for the world" strategy to a much more sophisticated and tactical approach, says Yves Rebetez, managing director and editor of ETF Insight, a Toronto-based online information source about ETFs.
"It really comes down to what you want to accomplish," says Mr. Rebetez. "There's the fully passive end of the spectrum with the traditional 60-40 (stocks to bonds) weighting. The flipside of that investing is about trying to figure out what could be working better or what is more timely."
Given the significant fall, rise and now decline of Canada's currency since the financial crisis of 2008, more ambitious investors may also want to look at moves that can help protect them against swings in the loonie or take advantage of foreign exchange swings.
"Once you are looking to non-Canadian exposure, you should consider what type of currency exposure you want: currency-hedged or unhedged or a tactical view," says Mr. Chiefalo. If investors are uncertain about the future direction of the Canadian dollar but want U.S. equities exposure, for example, he suggests they may want to consider a hedged stock ETF such as the iShares Core S&P 500 Index ETF (XUS) that effectively eliminates any exposure to the greenback.
The ever-expanding universe of ETFs, from simple index-tracking funds to sophisticated funds that seek specific investment goals, means that there is likely a low cost option, no matter what your individual investment profile.
"There really is a wide variety now," says Mr. Rebetez, "And a continued supply of additional ETF solutions that can help you articulate specific [market] views."
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