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Competing products vie for money on the move

As investors cautiously return to the markets, where will their cash go? For some, fees matter. For others, advice counts

Special to The Globe and Mail

Garth Rustand has no desire to revisit his old life as an active stock market player, riding out the highs and lows, constantly trying to beat the benchmarks. Been there, done that, got burned in the process. The former stockbroker now pursues a passive indexation strategy: His entire personal portfolio is invested in exchange-traded funds.

ETFs make up less than 5 per cent of the assets under management by mutual funds, but the ETF approach is being adopted by a growing number of Canadians during this registered retirement savings plan season.

Investors are weighing the benefits of more-costly, actively managed mutual funds - and the potential for big returns - compared to the lesser-known, passively invested ETFs, which typically replicate indexes in the stock and bond markets.

A broker with CIBC Wood Gundy before he left the industry in the wake of the 2002 tech wreck, Mr. Rustand knows better than most how tough it is to consistently provide above-average returns to investors, especially after annual management fees have been deducted.

Fees for equity mutual funds are roughly 2.5 per cent, on average, while ETFs, which generally require less oversight, charge between 0.25 and 1 per cent. Both vehicles offer investors a diversified asset mix, but Mr. Rustand, for one, believes ETFs offer better value even though they are not structured to outperform the benchmarks.

"When you index through an ETF, you have only the highest-quality securities. If you use the TSX 60, it's the 60 biggest and best companies in Canada. If you use the S&P 500, you get the 500 biggest and best companies in the United States," said Mr. Rustand, who also has a portion of his portfolio in an iShares fixed-income ETF.

"You don't have to worry about having a mutual fund manager putting in some little speculative mining stock," Mr. Rustand said in an interview from Nanaimo, B.C., where he is now executive director of Investors-Aid Co-operative of Canada, an independent advisory organization owned by 300 members. The co-op provides investor education and market research to consumers but does not sell investment products.

The cost advantage is leading more investors to consider ETFs, which now have more than $30-billion of assets under management in Canada, said Heather Pelant, managing director and head of iShares Canada at BlackRock Asset Management Ltd.

These ETF assets now represent the equivalent of 4.6 per cent of the assets under management by mutual funds, up from just 3 per cent at the end of 2008 - and the market share is growing, said Ms. Pelant, whose firm is the largest player in the Canadian ETF market.

"There is money in motion. A massive number of investors went to money market funds last year. Now, as they are coming back into the market, I think they are coming back in oftentimes through an ETF," Ms. Pelant said.

"I think Canadians are becoming a lot more savvy: 'I want the return, I want to understand the risks, and please tell me what it costs,' " she said.

Mutual fund management fees can quickly erode market gains, especially for smaller investors, she added. "If you are looking at a long-term horizon, as you should be when you are investing for retirement, that expense differential of 1 per cent or 1.5 per cent a year, compounded over the life of your investment, can make a huge difference to how you retire."

But, counters Thomas Dyck, president of TD Mutual Funds, investors "need to take into account the transaction fees that are associated with ETFs, the charges when they buy and sell the fund [on the stock exchange], in addition to the management expense ratios. ... The simple truth is, the more active you are, the more you buy and sell an ETF, the quicker the cost advantage to ETFs goes away, particularly for investors with more modest portfolios," Mr. Dyck said, noting that mutual funds also sell index products for investors who are simply looking for market exposure.

Mr. Rustand said, however, that he hasn't "seen any evidence that people should really bother with actively managed [mutual] funds."

Mutual fund providers say the rap against ETFs is that, once fees are deducted, the returns will always fall below the benchmarks.

"The primary advantage of mutual funds is that they are typically sold by financial advisers. Investing alone, without support and advice, is complicated, and, quite frankly, without any safety nets. Most investors are simply not equipped or motivated to actively manage their own portfolios," Mr. Dyck said. "High-quality active managers actually do outperform benchmarks."

"A key element of mutual funds is this access to advice and ongoing support," he added. "That's exactly what you pay for."




ETFs can be bought and sold on the stock market throughout the day at the current market price. Mutual fund prices can change between the time an investor decides to purchase or sell and when the end-of-day net asset value is calculated, according to the investor education portal on the TMX Group website.

But, says Thomas Dyck, president of TD Mutual Funds, "for the average long-term investor, the ability to trade at 2 o'clock in the afternoon or at the end of the business day is generally irrelevant to the long-term performance of their portfolio."

Minimum investment

Unlike mutual funds, there are no minimum investment requirements for ETFs. "You can be a retired schoolteacher and buy one share, and have the same experience as the world's biggest pension plan, which buys 10 million shares," says Heather Pelant of iShares Canada. Transparency

ETFs disclose their holdings on a daily basis, while mutual fund holdings typically are disclosed on a quarterly basis.

Diversification Mutual fund giant Mackenzie Corp. says an active mutual-fund manager can often provide better diversification than an index fund, which can be dominated by certain stocks or asset classes.

Virginia Galt

© 2007 The Globe and Mail. All rights reserved.

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