Exchange-traded funds (ETFs) are pools of investments that trade on a stock exchange. ETFs are attractive to retail investors because of their low cost, diversification, and share-like features.
You can generally find a copy of an ETF’s prospectus, along with specific, detailed, and up-to-date information about each ETF, on the fund company’s website.
The ETF’s prospectus and management report of fund performance is also available on SEDAR.com.
ETFs range from low- to high-risk investments.
An ETF can invest in equities, bonds, or commodities, and may specialize by industry, sector, or country. Each ETF has a different level of risk depending on its investment mix. This chart shows the risk of a variety of types of ETFs.
Passive Index ETFs
Risk Level: Low to Medium
Risk Source: Passive ETFs track an index. The risk of the ETF will depend on the volatility of the index the ETF tracks.
Actively Managed ETFs
Risk Level: Medium to High
Risk Source: Actively managed ETFs attempt to outperform a benchmark index by using strategies to meet an investment objective. The risk in actively managed ETFs comes from higher portfolio turnover compared to passive ETFs due to the portfolio manager actively trading the investments in the portfolio. This results in higher management fees and transaction costs compared to passive ETFs.
Inverse or Leveraged ETFs
Risk Level: High
Risk Source: These ETFs hold derivatives that mimic the performance of the index they trade. They have significant risks. See our Inverse and Leveraged ETFs section.
Because ETFs trade on an exchange, they are subject to many of the same risks as the investments they carry. ETFs that track a risky sector or specific country will be a higher risk than one that tracks a well-diversified index.
Tracking errors can occur when an ETF misses or is slow to follow index changes. Also, although ETFs have a mechanism to keep their trading price close to their net asset value (NAV), market conditions can interfere, causing you to pay more for the fund than the value of its underlying assets.
Can You Sell Them Easily?
Probably. You trade ETFs on a stock exchange like shares. ETFs can be bought or sold at any point during market hours like a stock.
Some ETFs do not trade frequently and may invest in market sectors where the underlying holdings do not trade frequently. These types of ETFs may be difficult to sell. Poor market conditions may also make it difficult to sell. You may need to wait, or reduce your price, to sell these ETFs.
What are the Costs?
Brokerage fees apply to buying or selling ETFs, just like buying and selling shares.
The MER for an ETF is usually lower than an indexed mutual fund or an actively managed mutual fund. This is because the fund manager usually follows an index and does not have to make as many investment decisions or trades. Most ETFs do not pay a trailer commission, another reason for an ETFs low MER.
In recent years, fund companies have launched actively managed ETFs that do not follow an index. These actively managed ETFs tend to have a higher MER compared to passive ETFs that follow an index, but generally have a lower MER compared to actively managed mutual funds.
What are Typical Returns?
When you sell your units, you will realize either capital gains if the market price has increased, or capital losses if the market price has decreased.
ETFs may also pay cash distributions from interest, dividends, or capital gains. You usually have the option of directly reinvesting your distributions.