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Exchange Traded Funds: A Low Cost Alternative to Mutual Funds
In today’s investment environment there are several opportunities and strategies available to the individual investor. Primarily, Canadian investors have been building their nest eggs using mutual funds and all too often suffer from high management fees and low returns. There is an innovative investment product available, as a low cost alternative to mutual funds, “Exchange Traded Funds”.
What are Exchange Traded Funds (ETF’s)?
ETF’s are units which trade on the major stock exchanges and provide investors with mutual fund like qualities at a lower cost. These funds hold stocks in the same proportion as their respective index using an indexing approach. For example, the S&P/TSX 60 index is tracked and traded using the iUnits i60. Some of the major ETF’s include the DIAMONDS (DIA) which tracks the Dow Jones Industrial Average, SPDR’s (SPY) which tracks the S&P 500, and the CUBES (QQQQ) which mirrors the Nasdaq 100. These units allow investors to purchase shares of the index which resemble the overall market.
Indexing VS Active Management
Indexing is a management style which tries to match the performance of a benchmark index like the S&P/TSX 60 index as mentioned above. Indexing managers in the case of iUnits, are simply buying and holding a basket of securities which match the underlying index. The only time a change is made to the portfolio is if a change is made to the index itself.
On the other hand active management is an attempt to outperform the market or a respective index. The fund manager uses their expertise to try and time the market and purchase the right securities. Several studies have shown that active fund managers generally under perform the index due to among other things, higher management costs.
Cost Matters!
ETF’s have much lower management expense ratio’s (MER’s) than mutual funds. MER’s are the fees the fund manager will collect for managing your fund. Since the ETF’s are simply following the index and not actively trying to outperform the index, their MER’s are significantly lower.
If you hold a large portfolio of Canadian equity mutual funds then the average MER would be about 2.29% (source: www.iunits.com). That means that whether your portfolio goes up, down or sideways the fund manager still receives their fees. The i60 for example has an MER of only 0.17%. Over 20 years the growth of $10,000 assuming an 8% rate of return would leave you about $15,000 less in your mutual fund portfolio compared to holding ETF’s. That’s significant!
Other reasons why to invest in ETF’s?
ETF’s are traded on the major stock exchanges therefore they are usually very liquid investments which can be bought and sold during trading hours, as opposed to mutual funds which are valued at the end of each day. Since ETF’s are traded on a stock exchange, investors can purchase them in the same manner as a stock. Therefore you can use limit or market orders, margin and even sell them short. For some ETF’s, listed options are available.
When ETF’s are purchased there is only the usual trading commission, there are no front or back end loads. Furthermore ETF’s are a tax efficient investment. Due to the infrequent turnover of holdings within most indices, the respective ETF can have less tax implications than a comparable mutual fund.
ETF’s are available for nearly every sector and index, iUnits and iShares cover more than 90 different indices globally. Thus, this broad range can provide you with the diversification your portfolio needs.
To find out what savings you would incur by switching your mutual fund portfolio or to find out more information about ETF’s please contact:
Chad Dawson
Investment Advisor
Union Securities Ltd
50 Queen Street North, Suite 140
Kitchener, ON N2H 6P4
call (519) 584-2600
or toll free at 1-800-264-3557
The information contained in this report is drawn from sources believed to be reliable, but the accuracy or completeness of the information is not guaranteed, nor in providing it does Union Securities Ltd. assume any responsibility or liability. This letter is not to be construed as an offer to sell or the solicitation of an offer to buy our securities and is intended for distribution only in those jurisdictions where Union Securities Ltd. is registered as an advisor or dealer in securities. This letter is not intended for, nor should it be distributed to, any person residing in the U.S.A. The inventories of Union Securities Ltd., its affiliated companies and the holdings of their respective directors and officers and companies with which they are associated may from time to time include the securities mentioned in this letter. Union Securities Ltd. is a member of the Canadian Investor Protection Fund and the Investment Dealers Association of Canada.
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