Common types of ETFs in Canada

Many investors know about exchange-traded funds, or ETFs as they’re better known. They’re a collection of securities (typically stocks and bonds) held in a fund that can be traded on the stock exchange. Originally, ETFs mostly offered a low-cost way of replicating the performance of a specific index (such as the S&P 500 or the S&P/TSX).

However, ETFs have evolved considerably since the first one was launched, in Canada in 1990. Some investors are unaware that there are actually several types of ETFs, and they can now deliver far more than simply copying a particular index’s performance.

The chart below illustrates the spectrum of the types of ETFs, with index ETFs on the left (which have the least active management, being a simple replication of an index). As we move further to the right, there is more active involvement from fund managers, as the goals of each type of ETF become more specific and complex.  

Let’s take a closer look at each of these types of ETFs:

What are traditional index/beta ETFs?

Also sometimes known as passive ETFs, these types of ETFs track an index (and the rules that the index follows). These are good examples of ETFs that provide investors with easy access to nearly every conceivable investment space on the planet, including geographical area (for example, the US, Canada and emerging markets), sectors and subsectors (for example, global infrastructure), and different asset classes (for example, equities and bonds).

These types of ETFs have brought a greater amount of democratization to investing; a few decades ago, access to some of these spaces was available only to institutional money managers, but now most individual investors can add them to their portfolios.

Index ETFs are low cost and offer daily transparency, so investors can know exactly what they own, at any given time. Their value also depends on how they’re used, which can range from the building blocks of a portfolio to a more tactical use, such as for rebalancing a portfolio.

For example, you could sell some of your loss-making assets for tax-loss harvesting purposes (where you offset your losses against your gains, so you pay less tax). Normally, you would have to wait 30 days to buy back into the same assets. However, if you don’t want to miss out on potential growth in those 30 days, you could buy an ETF that is very similar to that asset, but not identical. For example, you could sell a losing asset that follows a broad Canadian bond index and then buy an ETF that tracks a different broad bond index.

These types of ETFs offer precise and transparent portfolio construction at a low cost. Examples of index ETFs are the Mackenzie US Large Cap Equity Index ETF (QUU, which tracks large US companies) and the Mackenzie Canadian Equity Index ETF (QCN, which tracks a broad index of Canadian companies).

What are strategic beta ETFs?

Another example of ETFs is strategic (or smart) beta. These types of ETFs aim to deliver an improved performance compared to the index (known as delivering alpha). They do this by tweaking the indices/benchmarks, often across several factors, such as value, volatility, growth, geography and size. For example, there are times when small companies can perform better than large companies.

Some strategic beta ETFs adjust the weight of underlying stocks or bonds in order to mitigate the risks of high concentrations of just one company or sector. Asset managers could take on lower positions of what they consider to be high-risk companies, for example, so the fund’s risk exposure would be much lower if those companies’ prices plummeted.

Given the additional resources needed to screen for factors and risk, etc., these ETFs are typically pricier than index/beta ETFs. Your bet here would be on the factors that are working now and in the near term, plus the cyclical element of these factors and risks. An example of a strategic beta ETF is the Mackenzie Maximum Diversification Emerging Markets Index ETF (MEE), which aims to increase diversification, reduce risk and enhance returns.

What are actively managed ETFs?

These types of ETFs follow a manager’s active strategies, and can be found for fixed income, equity and balanced ETFs, as well those for different geographical regions. These managers aim to beat their benchmark’s performance, rather than track it. Skillful managers do this consistently, even when taking into account fees, which are naturally higher, given that they provide their secret sauce.

With these types of ETFs, you’re mostly betting on the skill level of the active manager. An example of ETFs that are actively managed is the Mackenzie Unconstrained Bond ETF (MUB), which provides exposure to a wide range of fixed income assets.

When should you use traditional index/beta, strategic beta or active ETFs?

A good place to start is to ask yourself the following three questions when looking at your total portfolio and its parts:

1. Is the sector or region you’re considering efficient? For example, many of the world’s analysts closely study US large cap equities (the most valuable American companies), looking for inefficiencies and information that isn’t yet priced into the market. As a result, this sector tends to be efficient, which means it can be very difficult to outperform a US large cap benchmark. Conversely, emerging market equity can be inefficient, because there is far less research available. For efficient spaces, it may make more sense to simply invest in low-cost index ETFs.
2. Are there active managers or strategic beta products that can consistently provide some value (such as above-average performance or better risk reduction) in the sector or region that you’re considering? Many active managers struggle to outperform their targeted index. SPIVA reports measure actively managed funds against their relevant index benchmark, so you can research which funds have performed well before investing in them.
3. Do you have the time and skill to find these successful products or managers? Do you have the appetite to research all the due diligence considerations? Index ETFs can be a good option for investors who don’t have the time and/or skill to fully research products, while strategic beta and actively managed ETFs should only be considered by investors with the necessary time and knowledge.

Learn more about the best types of ETFs for your portfolio

Choosing the right types of ETFs comes down to the potential benefits and fees involved, plus the time you can devote to choosing them. You can read more about ETF basics in our blog, What are ETFs and why should I care?

And to find out more about the most suitable types of ETFs for your investment style and portfolio, talk to your advisor.

Commissions, management fees, brokerage fees and expenses all may be associated with Exchange Traded Funds. Please read the prospectus before investing. Exchange Traded Funds are not guaranteed, their values change frequently and past performance may not be repeated. Please read the prospectus before investing.

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