Exchange Traded Funds (ETFs) are investment vehicles that combine some of the features of Mutual Funds with some of the features of individual stocks. Although they are structured and regulated like Mutual Funds, they are listed and traded on stock exchanges similar to stocks. ETFs are open-ended funds, which means additional units are generated and sold to meet consumer demand. In addition, they can be more tax-efficient than regular mutual funds due to their low trading volumes.
The world’s first ETF was launched in Canada on the Toronto Stock Exchange in 1990. The Toronto 35 Index Participation Units (TIPs) continues to be traded today under the ticker symbol XIU, but is now known as the iShares S&P/TSX 60 Index ETF.
There are three main types of ETFs:
Standard (index-based) ETFs replicate an index by creating a duplicate portfolio of the underlying stocks that are held on an exchange, matching their weightings exactly. If you purchased a TSX ETF, you would be investing in all of the stocks traded on the TSX in the amounts that they are represented on the exchange. Typically, the holdings of a standard ETF and their weightings are published daily, making them the most transparent of any ETF. These ETFs do not have a portfolio manager making investment decisions or adjustments based on market conditions. Therefore, they are considered to be passive investments and usually have the lowest fees. An investor confident in their ability to structure their portfolio and concerned mainly about fees would be ideal for this type of Exchange Traded Fund.
Rules-based ETFs take a goal-oriented approach rather than strictly following an index. They are constructed based on a defined methodology to achieve a specific objective. These types of ETFs follow an index focused on areas of the market that may offer higher returns or lower risks than standard ETFs. To do this, they will use alternative weighting schemes based on various criteria, which may include dividends, volatility, and/or revenue. Years ago, the TSX experienced significant fluctuations due to the large weighting that Nortel held on the exchange; essentially, this type of ETF would construct a portfolio adjusting the weightings of the underlying stocks to create a more ‘balanced’ portfolio. These ETFs retain the characteristics of passive investing including greater transparency. They will have lower fees than Active ETFs, but higher fees than Standard ETFs. They are also known as Smart Beta ETFs.
Active ETFs are constructed and managed almost the same as regular mutual funds. The portfolio manager can trade the underlying stocks/bonds as they see fit. The main difference is the timing of the trading. An active mutual fund manager can make trades immediately whenever market conditions and/or investment opportunities arise. Due to the way ETFs are constructed and traded on the exchange, changing the portfolio may take up to a week to process and/or implement. This type of ETF could invest in a particular sleeve of underlying stocks; an example would be the Dynamic Active Global Dividend ETF. For an Active ETF to be successful, the manager must maintain a balance between transparency and the need to be discreet about portfolio changes. Therefore, these ETFs are less transparent and have higher fees than Standard or Rule-based ETFs.
As you may have noticed, I am incorporating more ETFs into portfolios. If you want more information or would like to explore whether adding ETFs to your portfolio makes sense, please don’t hesitate to contact me.
Have a great weekend,
Tracey
Source: https://www.csi.ca/en/learning/courses/etfm
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