Exchange Traded Funds
An exchange-traded fund (EFT) is an investment vehicle which allows investors to invest into a basket of securities through a single security. ETF??™s track and aim to replicate results of a particular stock index or some ETFs are based on specific themes such as industries, geographies or commodities.(1) In Canada investors can buy into ETFs that replicate S&P/TSX and in U.S all major stock indexes such as Dow Jones industrial average, Standard & Poor??™s 500 index and the Nasdaq composite have ETFs based on them.
According to the Toronto Stock Exchange, it listed the first ETF fund in 1990 and now has over 70 ETFs trading on the TSX. (1). In United States, the first ETF was introduced in 1993 with the arrival of Standard & Poor??™s Depositary receipts (Amex:Spy) and today there are over 780 ETFs trading in the United States.
From the surface there are many similarities between mutual funds and exchange-traded funds as they both invest is a basket of securities that are available to an investor via a single security. However, both investment vehicles have some considerable differences in the way they are traded in the market and costs associated with the funds. Majority of the mutual funds are that are available in the market can only be traded once a day at their Net asset value at close of business day. Hence, an investor needs to wait until the end of the trading day to find out the unit cost of a specific mutual fund. ETFs; like stocks, can be traded throughout the day at the value which is close to their net asset value. Also since ETFs track a specific index or an industry the cost of managing these funds are quite a bit lower than mutual funds where the management expense ratio??™s tend to be between 1- 4 % of the total return. ETFs expense ratio average 0.55% around the entire ETF market(2). Based on the lower costs ETFs tend to be suitable for both a passive investor who is looking to invest for a long term basis as well as an active trader who wants to be able to sell or buy ETFs during the day at their specific target price.
ETFs also offer some tax efficiency when compared to mutual funds because of their ability to defer capital gains distribution due to a unique exchange structure based on the creation and redemption of large blocks of shares through transactions which authorized participants, ETF issuers have more flexibility to manage their costs basis, and as a result, post pone capital gains distribution. Compared to mutual funds where managers need to sell stocks and cash in gains every time they have a redemption request. An ETF investor will eventually have to pay taxes on his or her capital gains; however by being able to defer those taxes it provides them with an opportunity to generate additional debt (2).**** this is a maybe to include
ETFs can only be brought through a broker compared to mutual funds which can be purchased directly from the fund. Hence; there are costs associated with ETFs at initial purchase which can increase total cost ratio. Also, since an investor can trade ETFs just like a single stock in the market, there is bid/ask spread for the ETFs. This spread is very tiny for a very liquid ETF, however if the ETF is a niche international fund the spread can be quite large. Therefore ETFs have added costs associated which are not present with mutual funds and investors need do their due diligence when comparing costs of these two investment vehicles.
|Table 1: iShares ETFs listed on the TSX |
|Exchange Traded Fund |# Stocks in the ETF |MER Fee |
|iShares CDN LargeCap 60 Index Fund (XIU) |61 |0.17% |
|iShares CDN S&P 500 Index Fund (XSP) |501 |0.24% |
|iShares CDN Composite Index Fund (XIC) |253 |0.25% |
|iShares CDN MSCI EAFE Index Fund (XIN) |818 |0.49% |
|iShares CDN Dividend Index Fund (XDV) |30 |0.50% |
|iShares CDN Growth Index Fund (XCG) |63 |0.50% |
|iShares CDN Jantzi Social Index Fund (XEN) |60 |0.50% |
|iShares CDN Value Index Fund (XCV) |80 |0.50% |
|iShares CDN Completion Index Fund (XMD) |193 |0.55% |
|iShares CDN Energy Sector Index Fund (XEG) |58 |0.55% |
|iShares CDN Financial Sector Index Fund (XFN) |29 |0.55% |
|iShares CDN Gold Sector Index Fund (XGD) |35 |0.55% |
|iShares CDN Income Trust Sector Index Fund (XTR) |64 |0.55% |
|iShares CDN Materials Sector Index Fund (XMA) |54 |0.55% |
|iShares CDN REIT Sector Index Fund (XRE) |12 |0.55% |
|iShares CDN SmallCap Index Fund (XCS) |211 |0.55% |
|iShares CDN Tech Sector Index Fund (XIT) |8 |0.55% |
|Source: iShares.ca, Feb 21, 2008 |
Growth and Development of ETFs in Canada
Introduced in Canada in 1990 on the Toronto stock exchange, today there are over 70 ETFs trading on TSX with a market value of more than $21 million. TSX listed 22 new ETFs in the first half of 2008, which represents approximately 28% of all new TSX listing for that period.(1)
iShares, Horizons Beto Pro & Claymore are major designated issues of ETFs in Canada. iShares has the largest market share with over $13 billion in EFT assets (4). (http://ca.ishares.com/publish/content/related_documents/downloads/brochure/ishares_investor_brochure_EN.pdf)
ETFs have done well in the past few years in Canada based on their low MER ratios compared to mutual funds and have tripled in value from 2003 to 2008 as per graph (4).
These numbers are very impressive; however compared to U.S, Canadian investors have been slower to invest in this product. Based on the recent increase in offering of EFTs in Canada, they are expected to grow as more and more investors get to know more about these funds.
Mutual fund MER ratios have been historically very high in Canada (2.5%) and these funds offer a great alternative.(.30%)
EFTs can be held under an RRSP which offers great value to Canadians as they can use buy and hold strategy aswell as there are no minimum purchase requirements for many of the EFT funds available.
Passive management approach for EFTs in Canada. iShares looking at actively managed ETFs however not sure when they will come out with this product.
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