This RRSP season, will you choose an actively managed mutual fund, an index fund, or an exchange-traded fund?
Canadians have had a love affair with mutual funds for more than a decade, but ETFs, as they’re known, are gaining ground with investors.
With an equity mutual fund, a team of portfolio managers try to pick and choose winning stocks from all those in the market.
Some use a momentum approach, buying stocks that are expected to appreciate the most in value. Some emphasize value, and others stick to big well-known dividend paying companies. Ideally, these funds will chalk up higher returns when the market is going up, and protect investors from losses when the market is moving down. Of the three categories, these have the highest Management Expense Ratio or MER.
An index fund does away with trying to pick a winner. It replicates a stock market index such as the S&P/TSX Composite Index or the S&P or Dow Jones in the U.S. Investors can expect their index fund to match the ups and down of the market. These tend to have cheaper MERs.
An ETF is basically an index fund that is bought and sold like a stock. Unlike mutual funds, which can only be bought and sold at end-of-day prices, you can buy or sell them at any point during the trading day. These investments are the cheapest to own, with MERs that in many cases are just a fraction of those of actively managed mutual funds.
In Canada, four companies offer about 150 ETFs: Blackrock Inc., Horizons, Claymore Investments Inc., and the Bank of Montreal. That compares to about 10,000 different mutual funds.
By some estimates, ETF assets grew by about 30 per cent in Canada over the past five years. There is now about $30 billion under management, but that’s still a tiny fraction of the $686 billion in mutual fund assets under management.
Globally, there is about $1 trillion U.S. in ETFs.
Investors typically pay more attention to fees in a bear market, said long-time industry observer Dan Hallett. As well, few active managers were able to outperform during the latest market decline.
It’s not surprising that compared to Canada’s fully mature mutual fund industry, ETFs are growing and attracting new investors at a much quicker pace.
“Not everybody who is redeeming a mutual fund is making a beeline for an ETF, but certainly they’re taking some of that share. How much I think is a difficult thing to quantify,” said Hallett, director, asset management, with Highview Financial Group.
Industry data shows that investors flocked to ETFs as stock markets were moving down in 2008, but also as they were moving higher in 2009, said Heather Pelant, managing director of iShares Canada, at BlackRock Asset Management Canada Ltd. Ishares were the first ETFs in Canada are still the most popular.
“The last two years told a very powerful story that ETFs shone in a bear market and a bull market. It’s solidified that these are a new investment vehicle that’s here to stay,” Pelant said.
The vast majority of investors still are not aware of ETFs or how to use them in a portfolio, said Rajiv Silgardo, head of ETFs at the Bank of Montreal.
“We do need to make ETFs more accessible to the broad population of savers and investors in our market. The big issue right now is that all ETFs are listed and traded on stock exchange, so if you want to get one you have to have a brokerage account. It’s not as simple as walking into a bank branch and saying, ‘I want an ETF; get me one of those,’” Silgardo said.
BMO has 22 ETFs with about $250 million in assets under management. Experts say there are still good reasons to choose an actively managed mutual fund or an index fund rather than an ETF. For instance, if you are investing on a monthly basis, an index fund can reinvest the distributions with no extra commission costs.