A lower cost alternative to index funds, are Exchange Traded Funds. ETFs trade like a stock and other than the commission to buy and sell units, have a lower management fee than most index funds. While most ETFs are passive investment vehicles, meaning they track a specific index, many new ETFs actively rebalance based on various strategies, so there are now many factors to consider on ETFs. ScotiaMcLeod has prepared an excellent primer on exchange traded funds.
Many advisors and investors seem to have an all or nothing Mutual Funds vs. ETFs philosophy. We feel that both vehicles can be used to great advantage by investors, and both vehicles have issues that can hurt returns, and often professional advice can help sort out what sets of investment properties are best for your situation.
We can purchase ETFs in your account at ScotiaMcLeod, generally for the passive portion of your portfolio. The table, below, shows the number of funds and ETFs available for purchase in your ScotiaMcLeod account, as well as the costs associated with them. Note that the F class funds and normal ETFs are usually held in "Fee Based Accounts" and A class funds are held in traditional accounts.
Virtually every article in the media points out that the average fund MER is over 2%, and some ETFs have MERs at 0.17%. But as shown in the table above, this is often an apples to oranges comparison, and then also ignores trading costs and bid-ask spreads.
The bid-ask spread on ETFs is something that no one in Canada, except the Spiess McGlade Team seem to have done any research on. We reported on this in our June 2009 issue. The bid-ask spread on ETFs is more than what appears on the screen. On March 13, 2009, a simultaneous buy and sell order of 1,000 shares of the most liquid ETF, XIU resulted in a 0.5% difference in buy / sell prices, and a similar order of the small XGR resulted in a 1.7% bid-ask loss. Clearly there is an extra cost in buying and selling ETFs beyond stock trading commissions. We are actively encouraging more research in this area, both through our internal research departments and through our media contacts. We will update as more information becomes available.
Luckily, some of the disadvantages of ETFs are being eliminated. Claymore Investments now offer DRIP on their ETFs, and may have PAC and SWP plans available for ScotiaMcLeod accounts in the future. Dividend reinvestment is an important investment philosophy, and we applaud Claymore for adding this feature (although tracking the tax cost will become an issue for non-registered investors - see this article from Canadian Business on calculating your adjusted cost base for tax purposes.)
To provide easier access to ETFs, several fund companies are now offering mutual funds that only hold ETFs (see Listing).
Interestingly, while many proponents of ETFs suggest that they should replace active fund managers, ETFs are less likely to be held long term by investors. The turnover on QQQ in the US is over 3,500% a year! As a result, Index Fund pioneer John Bogle recently said that "Investors Are Getting Killed in ETFs":
The bottom line on this article, is not that ETFs are bad, just that they should not be used as short term trading vehicles, to follow hot fads. Buy and hold a few good broad-based ETFs (or index funds or active funds) and don't trade often.
Finally, there is one kind of ETF to be very careful about. Double Leverage ETFs have significant tracking error, and may not be suitable for many longer term investors. See "Understanding leveraged ETFs".
See below for a comparison of the properties of ETFs and index funds.
|Tax Efficient||Often but not always||Often but not always|
|Min Investment||Roughly $5,000
(board lot of 100)
|$50 in PAC plans|
|PAC / SWP Plan||Generally No
(Claymore may be available)
|Dividend Reinvestment||No (Except now on Claymore)||Yes|
|Bid Ask Spread||.5% to 1.7%||0|
|Cost to Buy Sell||Brokerage Commission for both buy and sell||None on most funds available at ScotiaMcLeod|
|Trades||Minute by minute like a stock||At the end of the day|
|MER||0.08% - 1%||0.3% - 2.2%|
|Leverage||Can be bought on margin, sold short or
bought at limit prices.
|Can be bought on margin only to 50% loan value|
|Services||Stop Loss orders possible||Convenient PAC and SWP plans, automatic DRIP,
no stop loss orders
|Availability in your ScotiaMcLeod account||120 ETFs and growing, including all US ETFs||40 Index Funds and growing|
See below for a list of popular ETFs available from Canada and the major US markets.
|XIU-TSE||TSE S&P 60||Domestic||iUnits / Barclay's Global Investors||0.17|
|TTF-TSE||TSE 300||Domestic||TD Canada Trust||0.25|
|SPY-Amex||S&P 500 (Spider) Depositary Receipt||Foreign||Amex||0.12|
|DIA-Amex||Dow Jones 30||Foreign||Amex||0.18|
|XIN-TSE||MSCI International Equity Index RSP Fund
(fund tracks MSCI's Europe Australia Asia and Far East Index)
|Domestic||iUnits / Barclay's Global Investors||0.35|
|XSP-TSE||S&P 500||Domestic||iUnits / Barclay's Global Investors||0.30|
Overall, ETFs and Index funds are cost effective, and can provide reasonable exposure to the equity markets. In strong up markets, they will outperform the majority of active fund managers. Their higher volatility however should make investors think before allocating large portions to a specific unit. The sector specific ETFs should be avoided. ETFs and index funds should never form 100% of a portfolio.
"In theory, there is no difference between practice and theory. But in practice, there is." Jan L.A. van de Spepscheut
In theory ETFs and Index funds should be simple, but in practice, it might be a bit more complicated.
From the Spiess McGlade Team
From the fund companies
In the media
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