Exchange-traded fund

From finiki
(Redirected from Exchange traded fund)
Jump to: navigation, search

An exchange-traded fund (ETF) is an investment fund traded on stock exchanges, much like stocks. An ETF holds assets such as stocks, commodities, or bonds, and trades close to its net asset value (NAV) over the course of the trading day. Most ETFs track an index, such as a stock index or bond index. ETFs may be attractive as investments because of their low costs, tax efficiency, and stock-like features.[1]

Only authorized participants, which are large broker-dealers that have entered into agreements with the ETF's distributor, actually buy or sell shares of an ETF directly from or to the ETF, and then only in creation units, which are large blocks of tens of thousands of ETF shares, usually exchanged in-kind with baskets of the underlying securities. Authorized participants may wish to invest in the ETF shares for the long-term, but they usually act as market makers on the open market, using their ability to exchange creation units with their underlying securities to provide liquidity of the ETF shares and help ensure that their intraday market price approximates the net asset value of the underlying assets.[2] Other investors, such as individuals using a discount broker, trade ETF shares on the secondary market.

An ETF combines the valuation feature of a mutual fund or unit investment trust, which can be bought or sold at the end of each trading day for its net asset value, with the tradability feature of a closed-end fund, which trades throughout the trading day at prices that may be more or less than its net asset value. Closed-end funds are not considered to be "ETFs", even though they are funds and are traded on an exchange.

An ETF often can be found that has a lower expense ratio than similar mutual funds. However, the number of ETFs available in the Canadian market is significantly lower than the total available in the much larger US market, so Canadian investors seeking certain categories or styles may find that no Canadian ETF is available.

Investors seeking to buy or sell positions in the less actively traded ETFs may also find that there may be poor liquidity and/or large bid-ask spreads. Additionally, many of the sector ETFs contain only a small number of stocks. Purchasers are encouraged to check the data provided on the vendor's website carefully before making a decision.

Towards the end of 2015, ETF providers in Canada were managing $88 billion in assets.[3]

ETF history

The creation of the modern ETF has roots on Toronto Stock Exchange with a security called TIPS; short for Toronto 35 Index Participation Units. This investment product allowed investors to participate in the performance of the TSE 35 Composite Index without having to buy shares of each constituent company in the index.[4] Toronto 35 Index Participation units (TIPs) were first listed on Toronto Stock Exchange in March 1990.[5]

Creating and redemption of ETF shares

ETF shares are created when an “authorized participant” (typically a large institutional investor) deposits a daily “creation basket” (or cash) with the ETF and the ETF issues to the authorized participant a “creation unit,” a large block of ETF shares (generally 25,000 to 200,000 shares). The redemption process works in reverse, an authorized participant presents the specified number of ETF shares to the ETF in exchange for a “redemption basket” of securities, cash, or both, which typically mirrors the creation basket.

The creation and redemption of units helps to keep the trading price of the ETF near the net asset value (NAV) of the ETF holdings. Deviations between an ETF’s market price and its underlying value create opportunities for arbitrage for authorized participants. The ability of authorized participants to create and redeem ETF shares helps the ETF to trade at a price that approximates its underlying value.

ETF providers

As of the end of 2015, there are twelve ETF providers in Canada[6]. The ETF providers can be distinguished by the differences in the philosophy, style and underlying indices used for their offerings. The following table lists the top-five providers by assets under management:

Provider # of ETFs[3] AUM ($M)[3] Website link
BlackRock Canadian-based iShares 104 46,267 link
BMO Exchange Traded Funds 63 24,164 link
Vanguard Investments Canada Inc. 21 6,254 link
Horizons Exchange Traded Funds 70 4,684 link
Invesco PowerShares 22 2,539 link
Total all providers 372 88,451

TMXMoney maintains a list of all Exchange Traded Funds (ETFs)[6] and Exchange Traded Notes (ETNs) that are publicly traded, sorted alphabetically by symbol and a glossary of ETF terms.

How to choose ETFs for index investors

With over 300 ETFs now listed on the TSX (see the table above) and over 1000 more on US exchanges, how does an index investor choose the right ETF for each asset class? Most index investors will opt for ETFs that follow the broadest possible indices using market capitalisation weights; these are also known as “plain-vanilla” ETFs. Examples of those are listed under Canadian equities, US equities, International equities and emerging markets. For plain-vanilla Canadian bond ETFs see conventional bonds. A list of recommended index funds and ETFs is maintained by Canadian Couch Potato.

Additional criteria listed by Investopedia are [7]:

  • assets under management at least $10 million (to make sure the ETF will still exist next year)
  • good liquidity and low bid-ask spreads (see also [8] and [9])
  • minimal tracking error (see also [10] and [11])

Another aspect to examine, especially for global stocks, is whether the ETF holds stocks directly, instead of holding shares of a US-listed ETF, as this can have tax consequences (see Tax-efficient investing). Currency hedging may or may not be desirable feature (see US equities and Foreign bonds for example).

If two ETFs under consideration are traded on the same exchange and fit the criteria above, then the one with the smaller management fee can be picked, although differences of a few basis points are totally insignificant compared to, say, picking the appropriate asset allocation or asset location (see [12]).

Canadian vs US-listed ETFs

ETFs covering Canadian asset classes will typically be purchased on the TSX. But ETFs covering asset classes such as foreign stocks or gold can be bought either on the TSX or on US exchanges. US-listed ETFs can have lower MERs, be more tax-efficient, or provide a wider selection of products. But if the investor buys US-listed ETFs with Canadian dollars, there will be currency conversion fees which can be high at some brokerages. Norbert's Gambit is one available option that can be utilized to minimize the currency conversion costs when buying or selling US-listed ETFs. Where possible, using a discount brokerage sub-account that matches the currency of the ETF helps to minimize currency conversion costs when distributions are received.

ETF trends

The following tables show the growth of ETFs in the Canadian market and the US market (for comparison purposes).

Canada ETF statistics[notes 1]
Year end # of ETFs Assets ($ Billions) New ETFs Closed ETFs
2009 111 32 34 0
2010 159 38 50 2
2011 227 43 70 0
2012 265 56 45 14
2013 284 63 NA NA
2014 340 77 NA NA
Sources: Morningstar Inc.[13][14] and Canadian ETF Association (CETFA)[15][16][17][18]

All of the 2012 ETF closures in Canada were from Horizons' ETF offerings. The common thread is poor trading volumes and assets under management of less that $5M each.[14]

Notes

  1. New and Closed ETFs as of December 7, 2012.
    Closed ETFs do not include ones slated to be shuttered.
US ETF statistics[19]
Year end # of ETFs Assets ($ Billions) New ETFs Closed ETFs
2001 102 83 22 0
2002 113 102 14 3
2003 119 151 10 4
2004 152 228 35 2
2005 204 301 52 0
2006 359 423 156 1
2007 629 608 270 0
2008 728 531 149 50
2009 797 777 120 49
2010 923 992 177 51
2011 1,134 1,048 226 15
2012 1,194 1,337 141 81

See also

References

  1. ETFs Changing the Way Advisors Do Business, According to State Street and Wharton Study, Business Wire (June 10, 2008), viewed February 22, 2014.
  2. ETF Basics: The Creation and Redemption Process and Why It Matters, viewed September 15, 2012.
  3. 3.0 3.1 3.2 CETFA November 2015 Statistics, viewed Dec 29, 2015.
  4. TMXmoney, Exchange Traded Funds - How ETFs are Created, viewed July 30, 2012.
  5. News Release | TMX Group - Toronto Stock Exchange celebrates 20 years of listing and trading Exchange Traded Funds, viewed July 30, 2012
  6. 6.0 6.1 Exchange Traded Funds - ETF Providers in Canada | TMXmoney | ETF Providers, viewed January 6, 2016.
  7. Investopedia, How To Pick The Best ETF, viewed Dec. 27, 2014
  8. Canadian Couch Potato, ETF Liquidity and Trading Volume, viewed Dec. 27, 2014
  9. Canadian Couch Potato, The Hidden Cost of Bid-Ask Spreads, viewed Dec. 27, 2014
  10. Canadian Couch Potato, How Well Does Your ETF Track Its Index?, viewed Dec. 27, 2014
  11. Canadian Couch Potato, What Causes an ETF’s Tracking Error?, viewed Dec. 27, 2014
  12. Canadian Couch Potato, ETF Choices Are Less Important Than You Think, viewed Dec. 27, 2014
  13. Record number of ETFs shutting down - The Globe and Mail, viewed September 13, 2012.
  14. 14.0 14.1 The year of the ETF closure|Morningstar, viewed December 8, 2012.
  15. CETFA Quarterly Report (Dec 30, 2011), viewed February 20, 2014.
  16. Canadian ETF Industry Has Record Year, viewed February 20, 2014.
  17. CETFA December 2013 Statistics (January 10, 2014), viewed February 20, 2014.
  18. CETFA December 2014 Statistics, viewed December 29, 2015.
  19. 2013 Investment Company Fact Book, viewed February 22, 2014.

External links