How much of what you know about ETFs is, in fact, a myth?
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“It doesn’t matter what wrapper the product is in. It all depends on what’s in the wrapper – what the underlying portfolio invests in,” says Pat Dunwoody, president of the Canadian ETF Association. MICHELLE SIU
In the field of exchange-traded funds (ETFs), several myths often keep Canadian investors sacrificing more of the returns on their investments than they should. Tell a friend or even a financial adviser paid on commission that you’ve decided to put some of your savings into ETFs, and you might hear one of the following three common misapprehensions.
Myth #1
ETFs are riskier than mutual funds
It’s a bit like saying red cars are faster than blue cars.
An ETF and a mutual fund are virtually identical pooled-investment vehicles that operate under the same regulatory regime, says Steve Hawkins, chair of the board of the Canadian ETF Association (CETFA). “Both provide exposure to an underlying asset class, sector or type of investment philosophy in one simple, easy to buy and sell package.”
CETFA president Pat Dunwoody puts it this way: “It doesn’t matter what wrapper the product is in. It all depends on what’s in the wrapper – what the underlying portfolio invests in.”
Myth #2
ETFs are great, but now there are too many of them
There are just over 800 ETFs and well over 3,000 mutual funds, says Mr. Hawkins. “There are over a hundred different mutual fund issuers and only 35 ETF issuers. But ETF investment is growing, and mutual fund investment is not, so everyone is talking about ETFs.”
For investors, choice is a good thing. The original index fund, passive, portfolio-core type ETFs are still available, but now there are also ETF solutions for almost all investors and all portfolio goals.
Myth #3
ETFs cause market crashes
No, they really don’t.
“The markets can become dislocated by various events, both on the equity and fixed income side,” says Mr. Hawkins. Even in a recent presentation he made to the National Stock Exchange of India, it was necessary to address this myth, he says. “Mutual funds make up trillions of dollars in investments, they’ve been around for more than 50 years, and they are invested in the same underlying securities that ETFs are. If there’s a huge market sell-off, people will sell their mutual funds and their ETFs.”
“This always makes a good headline, so we see it every once in a while,” says Ms. Dunwoody. “I think it’s a chicken-or-egg scenario. When there is a global event that causes a market to fluctuate, passive ETFs will move with the market. When market volatility increases, ETF trading increases as well. This then causes some people to argue that ETFs are causing the volatility, distorting prices of securities within the portfolio, but it’s simply not true. It’s a symptom of market volatility, not a cause.”
What myth irks you the most?
The biggest misconception about ETFs is that they are primarily used for passive investing, says Tyler Mordy, president and CIO at Forstrong Global Asset Management Inc. “Traditionally, superior stock selection has been viewed as the only way to outperform. But substantial value can be added through the active selection of entire investment classes. Rather than picking stocks, ETF investors can now select themes, trends and sectors for outperformance.”
The need for this approach has become difficult to ignore, he says. “In a globalized world, the drivers of portfolio returns are increasingly related to macroeconomics and other big-picture trends. It’s driving significant organizational change in the asset management industry – moving away from siloed products with specialist managers to more holistic portfolio solutions, with multi-asset class managers using ETFs.”
In fact, “most of the products that are launching now take an index approach and add factors that may appeal to certain investors. For example, it’s not the S&P 500, but the top 100 large-cap companies within that index. They’re active, but there’s no human intervention, which means there is no emotion. It’s still computer-driven,” says Ms. Dunwoody.
“Investors need to take a hard look at the fees that they’re being charged and see if there are better, more efficient investment vehicles that could improve their portfolio performance.”
ACTIVE versus PASSIVE
“Every year when the SPIVA active-versus-passive report comes out, we hear from other industry participants who say that – while there is a percentage of active managers who never outperform the market – no passive ETFs outperform the market,” says Ms. Dunwoody. “Which in essence is true, because the passive products track an index and then there is a small management fee deducted. But ETFs that track an index never claim to beat the market.” ETF investment, active and passive, is about the highest likelihood of meeting an investor’s return goals while controlling the things that can be controlled, like fees. “As always, it comes down to understanding your goals and finding products that will allow you to get there,” she says.
The bottom line
ETFs now provide exposure to almost every single asset class and sector that mutual funds do, says Mr. Hawkins. “Investors need to take a hard look at the fees that they’re being charged and see if there are better, more efficient investment vehicles that could improve their portfolio performance.
“If you’re being charged 1.5 per cent or two per cent for a mutual fund while you could own the same underlying securities for a substantially lower fee, it will have a significant impact on your long-term returns.”
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