The rising popularity of ETFs have also created a challenge of choice
Most investors know something about the benefits of ETFs, or exchange-traded funds: they're low-cost, they're simple to buy and sell and they're very "transparent," meaning it is easy to see what is in them.
But the rising popularity of ETFs have also created a challenge: there are a lot to choose from as newer versions are introduced that are increasingly more sophisticated and specialized. It's a challenge that has many investors wondering, how do you select the ETF that is right for you?
"It really depends what type of exposure you are looking for," says Pat Chiefalo, managing director and head of Canadian product at iShares Canada at BlackRock Asset Management Canada Limited. "Generally people don't invest in ETFs thinking about a particular benchmark, they invest thinking about exposure. As in, 'I would like exposure to U.S. equities,' or international equities or Canadian equities."
When it comes to ETFs that track the performance of U.S. equities, for example, it is a little more complicated than it first appears. Investors may immediately gravitate to funds that track the S&P 500, but that is hardly representative.
"It is a great benchmark, but you are restricting yourself to only holding large-cap U.S. stocks. There are also mid-cap U.S. stocks, small-cap U.S. stocks, micro-cap U.S. stocks. That could include 4,000-plus underlying stocks," says Mr. Chiefalo.
Faced with a dizzying array of choices, the BlackRock executive suggests that investors narrow their search by thinking about performance. "Performance can mean different things depending on the type of fund that you are looking at."
Performance should be looked at differently for a "plain vanilla, market tracking" ETF than it would be for a "strategic" fund that it designed to produce a desired outcome such as minimum volatility, says Mr. Chiefalo.
In the case of that basic index-tracking ETF – like the iShares Core S&P/TSX Capped Composite Index ETF (XIC) which follows the S&P/TSX capped composite index – he advises that investors look at how closely the ETF tracks the ups and downs of the benchmark, its fees and portfolio management expertise.
"If the ETF is managed effectively and has a very efficient cost structure around it, in all likelihood that ETF is going to work extremely well," he says. "The proof is in the actual results. You look at your benchmark return, you look at your ETF return. How close was it? These days we are talking about basis points," between the performance of the ETF and the actual index it follows.
When it comes to strategic or "outcome-orientated" funds such as minimum volatility or strategic fixed income (which respectively aim to minimize interest rate volatility and maximize yields) – your investor checklist is a bit different, says Mr. Chiefalo.
"Here, investors need to determine whether the fund is delivering on what it is intending to do," he says. "For example, do the minimum volatility funds exhibit that lower volatility that investors are looking for and are the returns of that fund comparable and similar to a traditional benchmark of that fund?"
While fund providers are churning out ever-more sophisticated products, keeping it straightforward is likely the best strategy for most investors, advises Bruce Sellery, financial expert and author of Moolala: Why smart people do dumb things with their money (and what you can do about it).
"Number one, start with simple. Simple, simple, simple," he says. "Most investors really only need four ETFs: Canada, U.S., international (and) fixed-income."
Mr. Sellery notes that the overwhelming majority of active fund managers fail to match or exceed benchmark returns on an annual basis, so investors should be quite happy to buy and hold funds that provide index-level returns at a fraction of the cost in fees, namely ETFs.
While financial institutions and the media focus on souped-up investment vehicles and complex strategies, average investors would be better off setting their sights slightly lower, he advises. "If most people got to just one rung below that, they would be so much better off."
When shopping for ETFs, Mr. Chiefalo suggests that investors investigate "other services or resources that an investor can leverage to help them build the type of portfolio that they want," such as online tools provided by banks or investment companies.
Finally, ETF investors need to take a good, long look at the ETF providers, he says. "Does the provider have good experience in creating and delivering ETFs? Is it reputable? Does it put investors first?"
iShares ETFs are managed by BlackRock Asset Management Canada Limited. Commissions, trailing commissions, management fees and expenses all may be associated with investing in iShares ETFs. Please read the relevant prospectus before investing. The funds are not guaranteed, their values change frequently and past performance may not be repeated. Tax, investment and all other decisions should be made, as appropriate, only with guidance from a qualified professional.
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