PETER DOLEZAL: Exchange-traded funds gaining in popularity

Although exchange-traded funds have many of the same characteristics as mutual funds, their fees are about one-fifth that of mutual funds

A recent survey by Leger Marketing found that only 18 per cent of Canadian adults are familiar with exchange-traded funds. However, once they learned about the benefits of ETFs, 74 per cent decided to utilize them as their investment vehicle of choice. Let’s look at what makes ETFs so attractive to the knowledgeable investor.

Although ETFs have many of the same characteristics as mutual funds, their fees, as expressed in their management expense ratios, are about one-fifth that of mutual funds.

ETFs are not actively managed by a fund manager. Nor do they try to beat their comparable index; they simply try to closely track it. Since less than 20 per cent of Canadian mutual funds successfully beat the index in any given year, the premium fees they charge are of very questionable value.

ETFs are bought and sold like a stock. There is a trading cost – as low as zero on the Claymore family of ETFs at Scotia I-Trade. More common however, is the $10 to $29 per trade with other discount brokers. Since most ETF purchases are for long-term investment time horizons, this cost is minimal. The advantage becomes even more apparent when one compares the portfolio’s MER cost, usually less than 0.5 per cent annually, to the average Canadian mutual fund MER of 2.48 per cent.

More than 220 ETFs are now available in Canada. More are being added almost monthly. They cover all sectors of the Canadian, U.S., and international economies in which one may wish to invest. Options range from entire indexes such as the TSX Composite and the Dow Jones Industrial Index, down to smaller index sectors such as Canadian oil sands, banking, insurance, and numerous others.

ETFs exist for both the equity component of an investor’s holdings, as well as for fixed-income segments such as bond and preferred share holdings. In short, ETFs can provide safety through diversification similar to that offered by mutual funds, but at a fraction of the cost.

Investors would not mind paying an extra two per cent in annual fees for a mutual fund, if the likelihood were high that the fund would more than make up the extra cost through even greater returns.

Unfortunately, with less than a 20 per cent chance of doing so, most mutual fund holdings would seem more of a gamble than an investment.

If, by using ETFs, an investor can achieve the same risk-minimization through diversification and can invest in similar sectors as offered by mutual funds, all at an annual MER cost reduction of approximating two per cent, this becomes an option to seriously be considered by a prudent investor seeking to optimize long-term returns.

A retired corporate executive, enjoying post-retirement as a financial consultant, Peter Dolezal is the author of three books. His most recent, The Smart Canadian Wealth-Builder, is now available at Tanner’s Books, and in other bookstores.