What are Exchange Traded Funds (ETFs)?

Exchange Traded Funds (ETFs) are investment vehicles that seek to replicate the performance of specific indices, benchmarks, or commodities through full index replication, sampling, or swap/forward agreements, and cover stocks, bonds, commodities, and currencies. ETFs trade on stock exchanges, providing investors with the trading flexibility of equities.

Where and how can I buy ETFs?

Because ETFs trade on stock exchanges, you can buy and sell ETFs like you do stocks. Online Brokerage firms offer an easy and cost-effective way to complete trades. In addition, Investment Advisors at full service brokerage firms are actively using ETFs in the portfolios they help their clients build and can offer additional guidance about the specifics of each fund.

What is the minimum I need to invest in ETFs?

There is no minimum requirement. As with stocks, you can invest any amount of money into ETFs. Keep in mind that most ETFs are charged commission fees by brokers, with the exception of select ETFs (46) in the Scotia iTrade Platform, and select ETFs (60) from Qtrade Investor.

What sectors and asset classes do ETFs cover?

ETFs provide access to a variety of asset classes and within these, a way to get exposure to more narrowly defined segment of the asset class in question. For instance, on the equity side, ETFs provide exposure to specific sectors (Financials; Utilities; Consumer Staples; Energy, etc), and on the Fixed Income side, exposure to specific maturity ranges or segments, as well as Corporate Bonds, and US and Emerging Bonds. On the commodities front, investors can gain exposure to basket of commodities, or individual ones, such as gold, silver, oil, natural gas.

One advantage of ETFs is that they provide investors access to markets that are otherwise not easy to gain exposure to. For example, a Canadian investor looking to invest in Emerging Markets can easily buy an Emerging Market ETF listed on the Toronto Stock Exchange. Note: Direct investment in foreign market may be restricted or subjected to regulations by the foreign jurisdiction.


How are ETFs similar to mutual funds?

Both ETFs and mutual funds have the legal status of “open-ended mutual funds”. They both provide instant diversification and the ability to gain access to either broad or targeted exposure. As large pools of funds, they benefit from superior pricing in terms of trade executions.

How do ETFs differ from mutual funds?

ETFs trade on stock exchanges throughout the trading day and can be sold short or bought on margin. Mutual funds, on the other hand, can only be created and redeemed at the end of day’s Net Asset Value and do not offer the flexibility of implementing short-selling strategies.

ETFs tend to passively track an index whereas most mutual funds are actively managed. That said, ETF providers have begun offering Actively Managed ETFs, which combine the attractive structural attributes of ETFs with active portfolio management. ETFs overall enjoy significant cost advantages over mutual funds, and provide superior transparency and generally greater tax efficiency.

What is indexing?

Indexing is a fund management technique that seeks to deliver the performance of an underlying index by passively tracking the group of securities within an index. Most passively managed ETFs pursue an indexing methodology to provide investors the returns of an index (less MER). Index funds generally have much lower management expense ratios (MERs) than those of actively managed funds.

What are actively managed ETFs?

Recent innovations in the Canadian ETF space have seen the launch of many actively managed ETF products (Horizons ETFs). Actively managed ETFs, instead of passively tracking indices, have portfolio managers who actively select securities in order to attempt to secure higher investment returns. The fees associated with these ETFs are higher than those of passively managed ETFs, but compare favorably with those of Mutual Funds.

Are ETFs’ assets under management (AUMs) and trading volume
good indicators of liquidity?

No. The most important aspect related to the liquidity of any ETF is that while the liquidity of the ETF itself (the ETF’s own trading volume on the exchange) may be deemed poor or limited, the key gauge of that ETF’s liquidity is the liquidity of its underlying exposure.

With the mechanism of creation and redemption of ETFs [link to education section 1.2], a designated broker (DB) is responsible for ensuring that market prices track the ETFs’ net asset value (NAVs). If the underlying securities can be easily bought and sold, a tight fit between price and NAV is easily maintained.

Hence, an ETF with small AUM and little trading volume can still be highly liquid if its underlying basket of securities is liquid.