ETF Trading Chart

What is an ETF and How Does it Work?

Canadian investors have multiple investment options, especially in the availability of financial instruments to trade in the market. One of the fastest-growing investment funds in Canada is the exchange-traded funds (ETFs).

ETFs have often been described as a basket of securities that trade on an exchange. It contains different investment types such as Bonds, stocks, and commodities.

You’ve probably heard of how stocks and other securities trade on an exchange but wonder how ETFs work and the benefits of their trading flexibility to investors. Look no further as this piece will you with detailed information and a guide on how the Exchange-Traded Funds (ETFs) work in Canada to aid you in making smart investment decisions.

What is An ETF?

An exchange-traded fund (ETF) is an investment fund or a collection of securities that investors can buy and sell on an exchange. ETFs provide investors with exposure to an underlying asset class, including stocks, commodities, and bonds.

With almost 800 Canadian ETFs and about $249,803 billion assets under management, according to the Canadian ETF Association (CETFA), investors are presented with multiple investment options to build their investment portfolio and get a high ROI.

How ETFs Work in Canada

Canada is one of the wealthiest countries in the world, with a thriving mining and energy sector among other industries in the economy. With these underlying assets, Canadian ETFs have become a sought out among smart investors, both in Canada and across the borders.

ETFs work like mutual funds, but the difference is how you buy and sell them. Exchange-traded funds are listed, bought,  and sold (traded) on a regulated stock exchange like the Toronto Stock Exchange (TSX). Unlike mutual funds, ETFs can trade on an exchange throughout the day, just like stocks.

Also, unlike the mutual funds that are ‘actively managed’ by fund managers who actively predict and trade stocks, the majority of ETFs are not managed but programmed with an algorithm that tracks the performance of a market index or sector such as the S&P 500.

An exchange-traded fund is a combination of several investment types that can be sold as a unit, making it a suitable choice to diversify an investment portfolio. ETFs hold the investment in a particular sector, region, or index to match the overall performance of the market.

As a result, you can have an ETF comprising hundreds of stocks in various industries or sectors or an ETF of a particular industry or index. For instance, a banking sector ETF would contain stocks of Canadian banks.

ETF Trading in Canada

The major participants in the ETF primary market are the ETF sponsors,  dealers,  and market makers. These participants create ETFs to trade on a stock exchange. When market makers or dealers create or purchase ETF units, they sell the same to ETF individual investors and financial advisors in the securities market. These investors also trade (buy and sell) ETFs through a discount brokerage account or a broker.

ETF can be bought and sold at the current market price from the beginning to the closing of the stock exchange. The ETF prices reflect the value of its underlying securities at the time of trading. The cost of an ETF may be more or less than the net asset value (NAV) of the underlying securities.

Why is ETF popular among investors?

  • ETF has low fees. ETF is passively managed, so you don’t have to pay for the services of any fund manager.
  • ETFs are less risky as your ROI depends on overall market performance, not on predictions of fund managers.
  • ETF investments are transparent, published daily.
  • ETFs can be bought and sold throughout the trading period on a stock exchange.
  • ETF has no minimum investment – you can start your ETF investment with a single unit of an ETF share.
  • ETF provides investment diversification as it is based on a benchmark index.

Types of ETFs

Here are some of the most significant categories of Exchange-Traded Funds (ETF) in Canada:

Active ETFs

Actively managed ETFs combine portfolio management with low fees to produce risk-adjusted returns. Active ETFs pick securities that have the potentials for good performance in the market.

Leveraged ETFs

Leveraged ETFs are designed to track and double the overall performance or daily exposure of an index, commodity, or benchmark. Leveraged ETFs such as the Horizons BetaPro S&P/TSX 60 Bull Plus and Bear Plus ETFs double the daily Return Of a particular index or commodity.

Sector/Industry ETFs

These are ETFs designed to track a particular industry to give investors exposure to that economic sector. You can trade ETFs in Energy, Health care, Financials, Utilities, Real Estate, Information Technology, Communications, etc.

Index or Stock Market ETFs

These are ETFs that track the stock market index, including bonds, commodities, and other indices, either for a specific sector index or a broad index. Examples are the S&P 500 and iShare Russell 3000.

International ETFs

These are ETFs that provide investors with exposure to international stocks and bond markets. Investors can trade on ETFs that track the performance of stocks in these categories:

  • Global ETFs track stock markets of specific countries, such as the Tokyo Stock Exchange (TYO) and the New York Stock Exchange (NYSE). Examples are the iShare Core All Country World ex Canada Index ETF (XAW), Vanguard FTSE Global All Can ex Canada Index ETF (VXC).
  • Developed Markets ETFs that track stocks of well-established economies like Australia, Germany, etc. An example is the iShare Core MSCI EAFE IMI Index ETF (XEF).
  • Emerging Markets ETFs track stock markets of emerging economies like Turkey, Russia, Brazil, and China. An example is the Vanguard FTSE Emerging Markets All Cap Index ETF (VEE).
  • Frontier Market ETFs track the stock market of companies outside the developed and emerging economy markets in Asia, Africa, and America, such as Croatia, Lithuania, Nigeria, Estonia, Slovenia, Mali, Vietnam, etc. An example is the iShare MSCI Frontier 100 ETF.

Commodity ETFs

These are ETFs that expose investors to the commodity market, including crude oil, natural gas, gold, etc. Investors can purchase the physical commodity or invest in equity companies involved in commodities.

Currency ETFs

Currency ETFs enable you to invest in foreign currencies by tracking single and multiple currency indices, such as euro, dollar, etc.

How To Trade Exchange-Traded Funds (ETFs)

Just like stock trading, you can buy and sell ETF on exchanges throughout the trading period. There are several available options for investing in Exchange-Traded Funds (ETFs) in Canada. While you may prefer the services of a financial advisor or brokerage, you should be aware of the cost and fees associated with using a brokerage.

However, one of the most comfortable options to invest in ETF is to open a brokerage account with a discount broker or online brokerage. Also known as online trading platforms or self-directed brokerages, online brokerages like Questrade, Wealthsimple Trade, and other virtual brokers provide DIY investors with the ability to choose their investment portfolios at low or no commission fees.

Alternatively, if you prefer to leave your ETF investments in the hands of a financial expert, you can employ the services of a Robo advisor who will provide you with ETF portfolios that match your risk tolerance at affordable management fees.

Another suitable option is to buy directly from ETF issuers. Do your research to know which ETF issuer enables the direct purchase of the particular ETF you wish to buy. Some Canadian ETF providers include Vanguard, BlackRock, iShares, BMO, Harvest, First Asset, RBC, Horizons, etc.

Conclusion

Exchange-Traded Funds (ETFs) are great ways to diversify your asset portfolios. It’s essential to understand the stock market trends and behaviours of each ETF indices before venturing into ETF investment.

ETF investments involve high risks yet have the potentials for high returns. As a result of its low fees and transparency, ETFs are ideal for beginners and seasoned investors.

FAQs

What are the downsides of ETFs?

Despite their low fees, ETFs are subject to management fees and other related expenses. Also, ETFs are subject to market fluctuation and the risks of their underlying investments.

Are ETFs a good investment?

Despite the risks involved in ETF trading, ETFs have become prevalent investments for both active and passive investors. ETFs provide low-cost access to a variety of asset classes, industry sectors, and international markets.

How many ETFs should I own?

There’s no minimum ETF investment. You can choose to have one or a combination of many ETF types. The average investor needs five to ten ETFs and exposure to the large, mid, and small markets, international, and emerging markets.

Can I Day Trade ETF?

Unlike mutual funds, investors can trade Exchange-Traded Funds (ETFs) all day long on an exchange.

Leave a Reply

Your email address will not be published. Required fields are marked *