Mutual Funds

ETFs make strides in marketplace

August 8th, 2008 Subscribe To Our Feed

Hybrid product. Offers more freedom than mutual funds

PAUL DELEAN, The Gazette
Published: 10 hours ago
In recent years, exchange-traded funds have made significant inroads in the Canadian investment marketplace, where they’re seen as a way of adding diversification to portfolios at relatively low cost. To explain what they are and how they function, we contacted Heather Pelant, head of business development, exchange-traded products, at Barclays Global Investors Canada Ltd., the company behind the iShares line of ETFs.
Q: What is an exchange-traded fund (ETF)?
A: An ETF is a hybrid product that combines some characteristics of an index (mutual) fund with those of a stock. Most ETFs invest in baskets of securities that track specific market indexes, which make them index funds in that regard. Like stocks, they can be bought and sold, long or short, on an exchange throughout the day.

Q: How does it differ from a mutual fund?
A: In several ways. MERs (management expense ratios) usually are lower than those of comparable mutual funds. Portfolio turnover is lower than mutual funds. Holdings are disclosed on a daily basis, whereas mutual funds disclose total holdings on a quarterly or semi-annual basis. They’re priced throughout the day, whereas mutual funds are priced once a day. Investors can sell them short, which they cannot for mutual funds. Investors can place a limit order (order to buy or sell at a specific price) on ETFs, but they cannot for mutual funds. They can be bought on margin the same way stocks can; mutual funds may or may not be available on margin, depending on the brokerage.
Q: How, and where, are ETFs bought and sold?
A: They’re sold like securities on stock exchanges and occupy brokerage accounts the same way stocks do.
Q: How varied is the selection?
A: According to a Morgan Stanley report from May, there were about 1,300 ETFs worldwide with more than $805 billion U.S. in assets. There are more than 80 in Canada, accounting for $20 billion in assets. There is an ETF on almost any asset class, sector or geography.
Q: Are they appropriate for the portfolio of an average investor, or only for someone who spends a lot of time researching and monitoring?
A: ETFs can be used by anyone from the average investor to the most sophisticated. If you invest in an ETF that tracks a well-known index, you are always certain about what you own. You can see the ETFs’ holdings on the ETF provider’s website or you can alternatively see the index holdings on the index provider’s website. This makes ETFs one of the most transparent investment vehicles. Most people need only follow news on the respective indexes or the markets in general to know how their investments are doing. This, in essence, may reduce the time spent monitoring or researching individual companies.
Q: Are ETFs protected against currency variations?
A: Not all ETFs are protected for currency fluctuations. Investors have to read the prospectus so they can understand the currency hedge that is put in place. iShares, for instance, offers three ETFs that are currency neutral: the iShares Canadian
S & P 500 index fund, the iShares Canadian Russell 2000 index fund and iShares Canadian MSCI EAFE index fund.
Q: What kind of fees do ETFs charge?
A: Fees vary depending on the provider or the asset class. At iShares, they range from 0.17 per cent to 0.55 per cent (annually).
Q: How are distributions paid out and treated for tax purposes?
A: The schedule of distributions varies based on the ETF provider. Some pay on a quarterly basis, some do it semi-annually. IShares doesn’t reinvest cash distributions, but dividend reinvestment programs (DRIPs) may be available at some brokerage firms for some iShares products. Distributions are taxed depending on their nature. Those characterized as Canadian dividends are taxed at the same rate as Canadian stocks. Income paid by fixed-income ETFs is taxed the same way as income paid on individual bonds, and capital gains are taxed at the same rate as capital gains on any security.