How do you choose between similar-looking ETFs?
Exchange Traded Funds have seen a meteoric rise in demand. In 2017, Canadians poured a record $26-billion into them, up 56 per cent from the previous year.1
ETFs allow investors to gain exposure to a wide range of assets. With some 600 available in Canada, and over 2,000 available in the U.S., it’s possible to construct an ETF portfolio to suit just about any investor’s goals, time horizon, risk tolerance and asset allocation strategy.
When it comes to choosing particular ETFs to suit your portfolio, you’ll find many similar options.
Here are six basic considerations to help you choose between similar-looking ETFs. Note that you can also find fund-specific information in ETF Factsheets. Each fund is required to provide a Factsheet that contains information such as the fund’s benchmark, assets, MERs, volatility, and objective.
Choose the lower-cost ETF
All else being equal, choose the ETF with the lowest cost, as measured by the MER. ETFs that passively track an index have the lowest management fees because they require limited hands-on decisions from the fund manager.
Actively managed ETFs (along with some specialty and thematic ETFs) on the other hand, generally have higher fees because their mandates require more hands-on decisions and oversight from the fund manager.
If you’re faced with a decision between ETFs that track the same benchmark in the same way, or actively managed or specialty funds with virtually identical mandates and holdings, then it usually makes sense to pick the one with the lowest fees. Paying a higher fee is unlikely to get you a better return and will only reduce your earnings.
Choose the ETF with the lowest volatility
Among similar ETFs, choose the one with lower volatility—a measure of the range of price fluctuation you can expect. Even among index-tracking ETFs with similar objectives, there are factors that can affect their volatility. One is the way the holdings are weighted.
For example, an ETF that is weighted by each stock’s market capitalization may be less volatile than one that holds equal amounts of each stock in the index.
The number of equities within an ETF can also have an impact on its volatility. An ETF containing only 15 stocks is likely to be more volatile than one with 50. ETFs with fewer equities can be dramatically affected by the performance of just one stock.
Choose the bigger ETF
Generally, bigger is better, in terms of the amount of assets in the ETF. Very small funds—say with less than $10 million—have fewer investors, lower trading volumes, and wider spreads between the buying and selling price. This means that when it comes time to sell your ETF, it may be difficult to get a good price. Bigger funds have advantages when it comes to keepings costs low, and maintaining liquidity and tight spreads.4
Consider currency-hedged versions of foreign asset funds
When buying foreign-equity ETFs, you’ll see that some are unhedged and some are hedged.
In an unhedged ETF, your investments are exposed to currency fluctuations between the Canadian dollar and the foreign currency. If the Canadian dollar rises or the foreign currency drops, your returns go down. If the loonie falls or the foreign currency jumps, your returns go up.
ETFs with currency hedging can protect your investment from these fluctuations. These funds use currency forward instruments to lock-in a specific exchange rate, sheltering your investment from currency volatility.
Consider Canadian- vs U.S.-listed ETFs
If you’re choosing between Canadian-listed and U.S.-listed ETFs with similar mandates, there are three considerations to be aware of: foreign exchange costs, management fees and taxes.
If you buy an ETF on an American exchange for an account denominated in Canadian dollars, you will pay foreign exchange conversion costs. Same goes if you receive dividends in American dollars. You can avoid these costs by holding the U.S.-listed ETFs in a U.S. dollar-denominated account.
There are a couple of advantages of U.S.-listed ETFs. One is that they may have lower fees than their Canadian equivalents. Another advantage comes into play for holdings within an RRSP or RRIF. The U.S. (and some other countries) applies a withholding tax on dividends for stocks owned by foreigners. Thanks to a tax-treaty between the U.S. and Canada, U.S.-listed securities held within an RRSP or RRIF are exempt. But if your exposure to U.S. stocks comes from Canadian-listed ETFs, the withholding tax is lost.5
How to get started
Here are some further resources that can help you to decide which ETFs might fit your investment goals:
- Find ETFs that fit into your investment strategy with the ETF Screener
- Find the most active and top performing ETFs with ETF Research
- See Qtrade’s list of commission-free ETFs
You can invest in ETFs with Qtrade Investor by registering here.
1 O’Hara, Clare. “The popularity of ETFs in Canada is growing at an amazing speed,” The Globe and Mail, January 10, 2018. https://www.theglobeandmail.com/globe-investor/funds-and-etfs/etfs/canadian-etfs-finish-2017-with-56-per-cent-sales-spike/article37568355/
2 Christopher Davis, “How much are your mutual funds really costing you?” Morningstar, July 20, 2016. http://cawidgets.morningstar.ca/ArticleTemplate/ArticleGL.aspx?id=760407&culture=en-CA (Accessed August 6, 2018).
3 “Horizons S&P/TSXIndex ETF.” https://www.horizonsetfs.com/etf/hxt (Accessed August 6, 2018).
4 Elvis Picardo, “How to pick the best ETF.” Investopedia, October 25, 2016.
https://www.investopedia.com/articles/exchangetradedfunds/08/etf-choose-best.asp (Accessed August 6, 2018).