‘What is ETF?’ is a clever phrase uttered in a bank TV commercial that talks about the growing popularity of these investment vehicles while still being unknown quantities to many people.
If you are wondering, “What is an ETF?” it stands for “exchange traded fund”.
Canadians are turning to them at a record pace with $53 billion being paid into them in 2021. Despite their rise, we’re not giving up on mutual funds, which have higher fees, among other differences.
“We continue to use superlatives to talk about the success of ETFs with new records, but many of these records don’t come at the expense of the mutual fund industry, which itself had a banner year in 2021,” said Michael Cooke, head of exchange-traded funds at Mackenzie Investments.
Cooke points to Mackenzie Investments’ year-end ETF report, which also revealed that the number of ETFs in Canada currently listed on exchanges like the Toronto Stock Exchange (TSX) is 1,177, compared to 1,010 in 2020.
Cooke’s assessment is correct. ETFs make up a big chunk of investor dough — about $347 billion last year in assets under management (AUM), according to figures from the Investment Funds Institute of Canada (IFIC).
The mutual fund market – which has been around for much longer and is generally easier to get to, widely offered by banks and credit unions – is much bigger. It’s also growing. Last year, dollars invested in Canadian mutual funds topped $2 trillion for the first time, up from $1.7 trillion in 2020.
If you’re an investor — as opposed to a saver — chances are you invest in mutual funds.
Good for you: Any investment strategy applied consistently over many years is likely to help you achieve your financial goals, such as retirement.
Yet, if you are still wondering “what is an ETF?” and having money to invest, it’s worth learning about the promising little sister of mutual funds, especially with the RRSP contribution deadline approaching on March 1st.
In fact, they are part of the same family.
Both use fund structures to hold diversified portfolios of stocks, bonds, commodities, or sometimes even other mutual funds or ETFs.
But mutual funds are often purchased through your financial institution, with trades settling at the end of the trading day. ETFs are bought and sold like stocks on a stock exchange during trading hours through an online broker or adviser.
Another key difference is management expense ratios — MERs. ETFs have much cheaper MERs. For example, the RBC U.S. Equity Fund (sold through an advisor) has an MER of 1.89% – not bad for an equity-based mutual fund – and an annualized return on 10 years of nearly 15% (ending Dec. 31) – again, pretty good.
But its comparable benchmark – the S&P 500 index listing the 500 largest publicly traded companies on the New York Stock Exchange – has an annualized return of almost 16.55% over the same period.
This is where ETFs show their value due to their origins, developed in Canada in the 1990s, as tools to capture the performance of indices like the S&P 500.
Rather than paying a manager about 2% of your assets each year to outperform this index – which is difficult to do consistently – you could pay less than a tenth of this MER and receive much of the same return as the ‘index.
For example, the US-listed iShares Core S&P 500 ETF has a 10-year average annual return of 16.5%. The difference between its performance and the S&P 500 and the RBC fund is its MER, which is 0.03% per year. In dollars, if you invested $10,000 over the decade, your money would have grown to $44,000 with the ETF versus around $39,000 with the mutual fund.
This illustrates a long-standing argument in favor of ETFs. They often offer superior growth because the added expense of a mutual fund for expert managers to select investments often dampens investment returns.
More generally, ETFs’ low cost and instant diversification across entire markets have made them convenient staples for all investors, including pension fund managers, says Mark Raes, head of ETFs and mutual funds at investment at BMO Global Asset Management.
“The ETF market has matured to a point where you can really feel comfortable building core allocations in a portfolio.”
Want to invest in the biggest stocks in Canada? All you have to do is buy an ETF that holds the 60 largest companies listed on the TSX.
While ETFs only make up about 12% of all investment funds, Raes says their growth rate outpaces mutual funds.
“A lot of the talk is around ETFs catching mutual funds, and the growth rate is definitely — if you look at longer-term trends — higher,” he says.
Again, he adds, ETFs have grown from a much smaller size over the past decade.
In 2012, ETFs had $56 billion in assets under management compared to $850 billion for mutual funds. Given their 10-year growth — over 600% for ETFs and nearly 250% for mutual funds — demand is strong for both.
In addition to offering low-cost diversification and total market exposure, ETFs are also a cauldron of innovation. There are ETFs offering exposure to gold, space companies, cryptocurrencies and even ESG (environmental, social and governance) strategies. Canada is once again a leader in bringing, for example, the first Bitcoin ETFs to market last year.
Another world first is a pair of carbon-neutral ETFs: Evolve’s CleanBeta ETFs for the TSX 60 and S&P 500.
“We had that ‘lightbulb’ moment about a year ago,” says Evolve chief executive Raj Lala. “We said, ‘What if we could take traditional indices and apply carbon offsets to the companies in the index, and provide investors with a carbon-neutral version of the index they already own? “”
Launched in May, Evolve’s ETFs got off to a “slow start”, says Lala, struggling to gain attention in a crowded market.
But like ETFs in general, Evolve’s funds are worth a closer look if you’re looking for innovative, low-cost – in this case carbon-neutral – strategies to build wealth for your future.