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Mutual Fund News

ETFs popular, but look at the fine print

Special to The Globe and Mail

Thinking ETFs for your RRSP? Canadians looking to build exchange-traded funds into their retirement portfolio will be spoiled for choice.

Since 1990, when the Toronto Stock Exchange created the world's first ETF, these investment bundles - which trade on a stock exchange and are linked to an index - have grown exponentially both in numbers and in popularity. Canadian-listed ETFs now total 250 funds, compared with a mere 34 five years ago, and last year boasted a record $56.4-billion under management - 30 per cent higher than in the previous year, according to the Canadian ETF Association.

"There's absolutely a growth in customer assets going into ETFs," says James Stares, Toronto-based director of product strategy for Scotia iTrade, the online brokerage arm of Bank of Nova Scotia. "We're seeing a migration from mutual funds to ETFs."

He points to ETFs' relatively low management fees as a key reason why many investors are switching over from mutual funds.

"ETFs have relatively low MERs [management expense ratios] compared to mutual funds - from five basis points up to maybe about 1 per cent," he says. "Whereas for mutual funds, this is significantly higher, so from a cost perspective, ETFs make sense."

So how do ETFs fit into a registered retirement savings plan? Allan Small, senior investment adviser at Dundee Wealth Management in Toronto, says ETFs are, like mutual funds, a good way for investors to gain exposure to a number of equities without having to buy individual stocks.

"It's a way to diversify at a lower cost," he says.

With so many ETFs to choose from, picking the right funds to add to an RRSP portfolio can be a challenge for investors. Today's ETFs don't just track a broad index such as the S&P/TSX composite index; some follow a specific sector such as banking, or a commodity such as oil or gold. Others provide exposure to currencies or offer a level of active management.

Mr. Small's advice to investors new to the world of ETFs: Don't be too proud to get a little bit of professional help.

"Work with an adviser to build a portfolio of ETFs," he says. "You have to understand what you're buying."

Whether they're working with an adviser or flying solo, investors need to consider the fundamentals before deciding which ETFs to add to their portfolio, says Alfred Lee, vice-president and investment strategist with BMO Asset Management Inc. As with any other investment, they should think about their long-term goals and how much risk they're willing to take.

Conservative investors, for instance, might be better off with a product like a low volatility Canadian equity ETF.

"That provides them with growth in their portfolio but is also a more conservative look at equities in general," says Mr. Lee.

On the other hand, an investor with a higher risk profile might look at ETFs linked to commodities or that are more sensitive to economic changes. These growth-oriented ETFs will give investors a greater potential for higher returns, but they'll also bring higher risks.

Because RRSPs are designed primarily for long-term savings, including more conservative ETFs - perhaps fixed-income or balanced multiasset class - would be a good idea for most people, Mr. Lee says.

Doing due diligence to really understand the differences between ETFs and the indices they're tracking is critical, he adds. For example, two ETFs tracking the same index may differ in how they're getting the exposure - one might own the basket of assets while the other is a funded swap structure, which means the ETF does not directly own the assets.

The latter provides investors with potential tax advantages but also exposes them to more risk.

Investors should also scrutinize ETF providers to get a good sense of their investment strategies and weighting schemes, which influence a fund's risk and returns.

"Also look at the level of servicing," Mr. Lee says. "Maybe information is easier to access with one provider over another - that's also an important consideration."

© 2007 The Globe and Mail. All rights reserved.

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