Investing in Exchange Traded Funds (ETFs): DIAMONDs, SPDRs, Qubes, HOLDRs, VIPERs, iShares
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ShareThisThey are simple and valuable investments with strange sounding names! Exchange Traded Funds (ETFs) essentially are mutual funds that trade like a stock. They are baskets of securities held in a trust (just like mutual funds) and can be traded as a listed security on a stock exchange (just like a stock).
Differences between mutual funds and ETFs
· Securities held in most mutual funds are actively managed. Securities held in ETFs track an index established by a stock exchange. Selection of securities is predetermined (i.e. passively managed). Accordingly, the cost of managing Exchange Traded Funds and their corresponding Management Expense Ratios (MERs) are significantly less than mutual funds.
· Mutual funds are priced once a day based on their net asset value at the end of the trading day. ETFs are priced in the market during the trading day based on their tracking value of the index that they represent.
· Mutual funds hold securities that are actively bought and sold during the year by managers who are using their expertise and experience to improve portfolio returns. ETFs, by definition, hold securities that are infrequently changed, and therefore tend to have lower capital gains distributions at the end of the year.
Differences between listed securities and ETFs
· Buying a diversified portfolio of individual securities, that approximately represents the market, can be time consuming and expensive. In contrast, buying an ETF, that holds a diversified portfolio of securities representing the market, can be completed easily in one trade.
· Transaction costs normally are lower for ETFs than for individual securities (particularly on broadly based ETFs) because bid/ask spreads for ETFs frequently are less.
Why the strange sounding names?
The names frequently are an acronym for an Exchange Traded Fund:
· SPDRs (also called SPDRS): Standard & Poor’s 500 index Deposit Receipts
· DIAMONDS: Dow Jones Industrial Average tracking unit.
· VIPERS: Vanguard Index Participation Equity Receipts
· Qubes: based on symbol for the NASDAQ 100 tracking units: QQQQ.
· HOLDRs: Holding Company Depositary Receipts
An Example using SPDRs
SPDRs are an Exchange Traded Fund that tracks the S&P 500 Index. SPDRs trade approximately at 1/10th the value of the Index. If the S&P 500 Index is trading at 1000, SPDRs (Symbol: SPY) will trade at almost exactly $100 per unit. The cost of 100 units will be $100 x 100 = $10,000 U.S.. If the S&P 500 Index rises to 1100, the price of SPDRs will increase to $110. The value of 100 units will improve to $11,000.
Types of Indices Tracked by ETFs
Seven types are available:
· ETFs on broadly based indices (e.g. S&P 500 Index, Dow Jones Industrial Average, S&P/TSX 60 Index)
· ETFs on sector indices (e.g. health care, high tech, financial services)
· ETFs on style indices (e.g. growth, value, small cap, medium cap)
· ETFs on indices of countries or regions outside of North America (e.g. the Euro 350 Index, the EAFE Index)
· ETFs on bond indices.
· ETFs on commodities and currencies
· Leveraged, inverse and inverse leveraged ETFs
Currently, 109 Canadian and 857 U.S. ETFs trade on North American equity markets. A complete list of Canadian ETFs is provided at the end to this report. A complete list of U.S. ETFs is available at www.etf.com
Reasons to own ETFs
- Easy to understand and to follow. The media frequently comments on events that influence the performance of broadly based indices such as the S&P 500 Index, the Dow Jones Industrial Average and the S&P/TSX 60 Index. Their comments also apply to performance of ETFs that track broadly based indices.
- A convenient way to build a diversified portfolio. Each ETF owns a basket of securities. For example, iUnits in the S&P/TSX 60 Index holds a diversified portfolio of Canada’s top 60 companies. Risks associated with ownership of individual securities in the basket are reduced.
- A low Management Expense Ratio (MER) relative to actively managed investments. The average MER on a broadly based Canadian or U.S. mutual fund actively managed by a Canadian based investment firm is 2.50%. In contrast, the MER on iUnits on the S&P/TSX 60 Index is only 0.17% and the MER on SPDRs is only 0.10%. A list of MERs on ETFs is provided at the end of this report.
- More tax efficient than actively managed investments. Capital gains distributions at year-end from U.S. traded ETFs currently are nil due to their legal structure. Capital gains distributions at year-end from Canadian traded ETFs are low and frequently are nil. The reason: changes in indices are infrequent and, therefore, chances of realizing a capital gain for tax purposes due to index changes are low. In contrast, a portfolio of actively managed investments frequently is adjusted and is more likely to distribute taxable capital gains at the end of the year.
- Easily bought and sold (particularly ETFs on broadly based indices). SPDRs were the most actively traded equity security in the world in 2009 based on value of trading. Qubes were the most actively traded security in the world in 2009 based on the number of shares that traded. Volumes in both ETFs rose in 2009. Average daily volume in i60s, Canada’s most actively traded ETF recently has been averaging 15 million units per day. In addition, bid/ask spreads on broadly based ETFs frequently are $0.10 per unit or less.
- Better performers relative to most actively managed investments.
Standard and Poor’s recently issued its Canadian “Standard & Poor’s Indices
Versus Active Funds Scorecard” (SPIVA) report for the period ending September 2009. Link to the report is
http://www2.standardandpoors.com/spf/pdf/index/SPIVA_Canada_Q32009_Report.pdf
The report once again confirms that most of Canada’s actively managed mutual funds have underperformed their benchmark indices.
Results of the study revealed the following:
The cost of buying and selling ETFs
Investors can choose between buying and selling ETFs in a transaction-based account or in a fee-based account. Costs in a transaction-based account will be the regular commission charged by your broker for completing an equity trade. Costs in a fee-based account in most cases will be zero for the transaction, but a fee based on the value of the portfolio will be assessed periodically. Investors, who make most of their own investment decisions, probably will prefer a transaction-based account. Investors, who rely on their broker to offer investment advice on a continuing basis, may prefer to complete transactions through a fee-based account. A fee of 1.5% per year for an equity account valued between $100,000 and $500,000 is approximately “the going rate” by Canadian investment dealers.
Other features of ETFs
The following information was obtained from publicly available web sites:
· ETFs listed on the Toronto Exchange are 100% eligible as Canadian content in tax deferred accounts (e.g. RRSPs, RRIFs. TFSAs).
· Most ETFs pay a quarterly dividend.
· Dividends paid by ETFs with Canadian equity content listed on the Toronto Exchange are eligible for the Dividend Tax Credit.
· Trading hours correspond with the regular trading hours of the Toronto Exchange and U.S. exchanges (normally 9:30 AM – 4:00 PM Eastern time).
· All ETFs have redemption features. Holders with large positions in ETFs are allowed to exchange their units for shares that underlie the unit. Net result: units consistently trade at or near their net asset value.
· Many ETFs have listed options and Long term Equity APpreciation Securities (LEAPS). A list of optionable ETFs is provided at the end of this report.
· Dividend re-investment (DRIP) programs on broadly based ETFs are available through selected brokers.
· ETFs are marginable.
· ETFs can be shorted.
· ETFs are sponsored by well-known financial institutions.
Portfolio Strategies
Core and satellite investing
One of the more popular strategies! Investors place a large portion (i.e. the core) of their equity portfolio into Exchange Traded Funds. This portion acts as the anchor for the portfolio, ensuring that portfolio performance will approximate stock market returns. Size of the core depends upon the amount of stock market risk that the investor is willing to assume. Investors, who are satisfied with realization of returns that approximate “the market”, will place a larger portion of their portfolio into ETFs (say 40%-80%). Investors, who are willing to take more risk in order to improve prospects for “outperforming the market”, will place a smaller portion into ETFs. The remainder of the portfolio is invested into “special situations” with the potential to outperform the market. Choices include attractive equities, specialty mutual funds, sector ETFs, hedge funds, etc.
Portfolio Rebalancing
ETF positions can be adjusted easily when equity, fixed income and cash weights in a portfolio need to be rebalanced due to changing market conditions. With one trade in an ETF of a broadly based index, equity positions can be increased or reduced.
Sector Investing
Investors can choose, when timely, to over weight sectors that have better potential. Investors can choose between six Canadian sector ETFs and over 60 U.S. sector ETFs.
Seasonal Trend Investing
North American, European and Japanese equity markets tend to be strongest from the end of October to the end of March /April. Investors can take advantage by owning broadly based ETFs during the period of seasonal strength and by switching into treasury bills during the remainder of the year.
Sectors in equity markets also have seasonality and can be traded accordingly. See the Special Report section at www.timingthemarket.ca for background.
Risks
By definition, an investor holding an Exchange Traded Fund will never outperform the market. The investor will track the market (less a small MER).
Some ETFs have a high percent of their portfolio invested either in a sector or an individual security. Concentrations can influence the volatility and performance of the ETF.
A small number of ETFs hold a basket of securities that are known to be volatile. Most of these hold high tech securities with a history of significant price swings.
Monitoring ETFs through the Internet
The following web sites are useful for investors who are looking for more information about ETFs:
Sites for a quick overview and description of ETFs that trade on U.S. exchanges:
ETF content and weights:
IShares U.S. information: www.us.ishares.com/home
iShares Canadian information: www.ca.ishares.com/index.do
Select sector SPDRs information: www.spdrindex.com
StreetTracks ETF information: www.streettracks.com
Merrill Lynch HOLDRs information: www.holdrs.com
Vanguard ETF information: www.personal.vanguard.com/us/funds/etf/byname
PowerShares ETF information: www.powershares.com
FT Portfolios ETF information: www.ftportfolios.com
Proshares ETF information: www.proshares.com
Rydex Funds ETF information: www.rydexfunds.com
Wisdomtree ETF information: www.wisdomtree.com
Claymore Investments ETF information: www.claymoreinvestments.ca
XShares ETF information: www.xshares.com
ETF information: www.exchangetradedfunds.com
Horizon BetaPro: www.hbpetfs.com
Index providers:
S&P indices: www.standardandpoors.com
Dow Jones indices: www.djindexes.com
MSCI International indices: www.msci.com
Russell indices: www.russell.com
Wilshire indices: www.wilshire.com
FTSE group indices: www.ftse.com
Index universe: www.indexuniverse.com
ETF Information and opinion sources
Exchange Traded Fund List
Fixed Income Units Traded in Canada
Equity and Fixed Income Units Traded in the U.S.
A list of U.S. units, their MERs, asset values and symbols is available at www.etf.com. The list is available in alphabetic order. In addition, the list can be screened by sector, country and style.
Comments on Exchange Traded Funds regularly appear at www.dvtechtalk.com
Disclaimer: Comments and opinions offered in this report are for information only. They should not be considered as advice to purchase or to sell mentioned securities. Data offered in this report is believed to be accurate, but is not guaranteed.
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February 17th, 2010 at 7:16 am
[...] Tech Talk’s team has updated the basic report on Exchange Traded Funds. Updates include a listing of all Canadian ETFs, their MERs and their optionable status and their average daily volume in recent months. The report has been archived in the Education section. It is available at http://www.timingthemarket.ca/techtalk/2010/02/14/investing-in-exchange-traded-funds-etfs-diamonds-s... [...]