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.
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. 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 $88 billion in assets.
The creation of the modern ETF has roots on Toronto Stock Exchange with a security called TIPS; short for Toronto 35 Index Participation Units. This investment product allowed investors to participate in the performance of the TSE 35 Composite Index without having to buy shares of each constituent company in the index. Toronto 35 Index Participation units (TIPs) were first listed on Toronto Stock Exchange in March 1990.
ETF shares are created when an “authorized participant” (typically a large institutional investor) deposits a daily “creation basket” (or cash) with the ETF and the ETF issues to the authorized participant a “creation unit,” a large block of ETF shares (generally 25,000 to 200,000 shares). The redemption process works in reverse, an authorized participant presents the specified number of ETF shares to the ETF in exchange for a “redemption basket” of securities, cash, or both, which typically mirrors the creation basket.
The creation and redemption of units helps to keep the trading price of the ETF near the net asset value (NAV) of the ETF holdings. Deviations between an ETF’s market price and its underlying value create opportunities for arbitrage for authorized participants. The ability of authorized participants to create and redeem ETF shares helps the ETF to trade at a price that approximates its underlying value.
As of the end of 2015, there are twelve ETF providers in Canada. The ETF providers can be distinguished by the differences in the philosophy, style and underlying indices used for their offerings. The following table lists the top-five providers by assets under management:
|Provider||# of ETFs||AUM ($M)||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|
|Total all providers||372||88,451|
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.
- assets under management at least $10 million (to make sure the ETF will still exist next year)
- good liquidity and low bid-ask spreads (see also  and )
- minimal tracking error (see also  and )
Another aspect to examine, especially for global stocks, is whether the ETF holds stocks directly, instead of holding shares of a US-listed ETF, as this can have tax consequences (see Tax-efficient investing). Currency hedging may or may not be desirable feature (see US equities and Foreign bonds for example).
If two ETFs under consideration are traded on the same exchange and fit the criteria above, then the one with the smaller management fee can be picked, although differences of a few basis points are totally insignificant compared to, say, picking the appropriate asset allocation or asset location (see ).
Canadian vs US-listed ETFs
ETFs covering Canadian asset classes will typically be purchased on the TSX. But ETFs covering asset classes such as foreign stocks or gold can be bought either on the TSX or on US exchanges. US-listed ETFs can have lower MERs, be more tax-efficient, or provide a wider selection of products. But if the investor buys US-listed ETFs with Canadian dollars, there will be currency conversion fees which can be high at some brokerages. Norbert's Gambit is one available option that can be utilized to minimize the currency conversion costs when buying or selling US-listed ETFs. Where possible, using a discount brokerage sub-account that matches the currency of the ETF helps to minimize currency conversion costs when distributions are received.
The following tables show the growth of ETFs in the Canadian market and the US market (for comparison purposes).
|Year end||# of ETFs||Assets ($ Billions)||New ETFs||Closed ETFs|
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 $5M each.
- New and Closed ETFs as of December 7, 2012.
Closed ETFs do not include ones slated to be shuttered.
|Year end||# of ETFs||Assets ($ Billions)||New ETFs||Closed ETFs|
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