In the years since they were first launched, ETFs have become a popular alternative to mutual funds
Most people who follow the investment world acknowledge that it changed when the first exchange-traded funds (ETFs) were launched 25 years ago. Warren Collier, managing director and head of iShares Canada at BlackRock Asset Management Canada Limited, thinks that change was part of a journey that's still going on.
"ETFs are the next step in the democratization of investing," he says.
In the years since they were first launched, ETFs have become a popular alternative to mutual funds. To Mr. Collier, ETFs are an evolutionary development. "Mutual funds were a very important first step," he says, but while the two products have similarities, they're not the same.
"[ETFs] can provide a more efficient way for investors to get access to markets and market insights," he explains.
ETFs, like mutual funds, are baskets of securities. Unlike mutual funds, they trade just like stocks, at any time when the markets are open. Mutual funds are typically only traded once a day.
Mutual funds are run by portfolio managers, many of whom buy and sell individual securities in hopes of beating the returns of a particular benchmark such as the S&P/TSX composite index. This market-topping objective may be difficult to accomplish, particularly once investors' fees for this type of management are considered.
Most ETFs, on the other hand, are run by portfolio managers who buy securities in order to match the returns of broad-based indexes or more narrowly-focused sectors or industry benchmarks as best as possible — for example, health-care related stocks or technology stocks or the stocks that make up the S&P 500.
Other exchange traded funds are managed to outperform market returns using pre-determined models and rules, but fees for exchange-traded funds are generally cheaper than for mutual funds.
"One of the things ETFs have done everywhere, but most noticeably in Canada, is to provide a lower cost vehicle for investors to get access to the same types of investments that they were often getting through mutual funds," says Mr. Collier.
ETFs are also more transparent than mutual funds.
"As an investor [in ETFs], you know at any point on any day what you have exposure to, unlike a traditional mutual fund where, depending on where in the world you sit you have to wait until the end of the month or the end of the quarter [for a report]," he explains.
Bruce Sellery, business and finance expert and author of The Moolala Guide to Rocking Your RRSP, says that one of the biggest benefits of ETFs for retail investors is diversification at low cost.
"Historically this was hard to do because you had to buy a basket of securities yourself. Now you can do it for 'pennies a glass' — less than a tenth of the average MER (management expense ratio) of many mutual funds in Canada," he says.
ETFs have evolved a great deal since the early days when there were only a few selections, such as a TSX-based index. "Now you can get diversification on virtually any index or sub-group in the world," says Mr. Sellery.
While ETFs are relatively easy for self-directed investors to use, they are also handy investment tools for investors who work with a financial advisor, says Mr. Collier.The ability to track an ETF and buy or sell it throughout the trading day "gives you and your advisor a lot more flexibility in managing your portfolio, in terms of your risk tolerance, your objectives and goals."
One aspect of the evolution of ETFs is that some are now actively managed by professionals, though, again, at a lower cost to investors than traditional mutual funds, says Mr. Collier.
"If you look around the world today, a lot of ETFs offer active strategies. They're primarily model-driven active strategies," he explains.
This keeps management costs down because it does not involve as much direct stock-monitoring and picking as a typical mutual fund manager would require. A model-driven strategist will establish a set of technical rules for what kinds of securities to include in the ETF rather than watching stocks incessantly.
"It's not pure stock picking, but it's a lot more than just tracking a well-known public index all the time," says Mr. Collier.
Some investors may not be aware of the extent to which many ETFs have evolved to embrace active management, he adds. This evolution gives investors more choice and the comfort of knowing the investment is being monitored by a manager without the higher fees.
"If you believe that there is a manager out there who can consistently outperform those [model-driven] indices, then the mutual fund model is still there for you," says Mr Collier. "But ETFs can add transparency and lower costs."
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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