Podcast
Questions and Answers
What is a key benefit of ETFs compared to mutual funds?
What is a key benefit of ETFs compared to mutual funds?
Which type of ETF allows for the replication of a reference index?
Which type of ETF allows for the replication of a reference index?
How have ETFs changed the landscape of investing for small investors?
How have ETFs changed the landscape of investing for small investors?
What type of ETFs are designed to provide exposure to a selected group of assets typically seen as high-risk?
What type of ETFs are designed to provide exposure to a selected group of assets typically seen as high-risk?
Signup and view all the answers
Which of the following ETFs would most likely use a strategy that seeks to profit from falling prices?
Which of the following ETFs would most likely use a strategy that seeks to profit from falling prices?
Signup and view all the answers
What is a defining characteristic of rules-based ETFs compared to traditional ETFs?
What is a defining characteristic of rules-based ETFs compared to traditional ETFs?
Signup and view all the answers
Which option correctly describes the alternative weighting schemes used by smart beta ETFs?
Which option correctly describes the alternative weighting schemes used by smart beta ETFs?
Signup and view all the answers
What is the primary goal of rules-based ETFs?
What is the primary goal of rules-based ETFs?
Signup and view all the answers
What distinguishes the BMO MSCI USA High Quality Index ETF as a smart beta ETF?
What distinguishes the BMO MSCI USA High Quality Index ETF as a smart beta ETF?
Signup and view all the answers
How do rules-based ETFs usually provide transparency about their holdings?
How do rules-based ETFs usually provide transparency about their holdings?
Signup and view all the answers
What category of distributions from ETFs is treated as ordinary income to investors?
What category of distributions from ETFs is treated as ordinary income to investors?
Signup and view all the answers
What is the main purpose of using a sampling approach in ETFs?
What is the main purpose of using a sampling approach in ETFs?
Signup and view all the answers
Which of the following is NOT a potential taxation impact for investors holding ETFs in a non-registered account?
Which of the following is NOT a potential taxation impact for investors holding ETFs in a non-registered account?
Signup and view all the answers
Which factor generally causes a higher risk of tracking error associated with mutual funds compared to ETFs?
Which factor generally causes a higher risk of tracking error associated with mutual funds compared to ETFs?
Signup and view all the answers
What factor contributes to the tracking error risk associated with ETFs using a sampling method?
What factor contributes to the tracking error risk associated with ETFs using a sampling method?
Signup and view all the answers
Distributions from Canadian companies lead to a different tax treatment for which type of investors?
Distributions from Canadian companies lead to a different tax treatment for which type of investors?
Signup and view all the answers
How does cash drag affect the performance of a fund?
How does cash drag affect the performance of a fund?
Signup and view all the answers
Under which circumstance are investors likely to see a higher frequency of distributions from an ETF?
Under which circumstance are investors likely to see a higher frequency of distributions from an ETF?
Signup and view all the answers
What is one reason ETFs may hold cash even though they typically minimize cash drag?
What is one reason ETFs may hold cash even though they typically minimize cash drag?
Signup and view all the answers
Which of the following is a challenge faced by ETFs when rebalancing?
Which of the following is a challenge faced by ETFs when rebalancing?
Signup and view all the answers
Study Notes
Exchange-Traded Funds (ETFs)
- ETFs combine features of mutual funds and individual stocks.
- They are structured as open-end mutual fund trusts and regulated like other mutual funds.
- ETFs can be actively or passively managed, though most are passively managed.
- ETF units trade on stock exchanges, like stocks.
- They can be bought on margin and sold short.
- Some ETFs have options trading.
Learning Objectives
- Explain regulatory requirements and different legal structures of ETFs.
- Describe key features of exchange-traded funds.
- Differentiate among types of ETFs.
- Identify risks specific to ETFs.
- Compare ETFs and mutual funds.
- Summarize taxation impacts of investing in ETFs.
- Identify investment strategies involving ETFs.
- Define mutual funds of ETFs and exchange-traded notes (ETNs).
Content Areas
- Regulation and structure of Exchange-Traded Funds
- Key features of ETFs
- Various types of ETFs
- Risks of investing in ETFs
- Comparing ETFs and mutual funds
- Taxation of investors in ETFs
- Investment strategies using ETFs
- Other related products
Key Terms
- active ETFs
- core holdings
- commodity ETFs
- covered call ETFs
- designated broker
- equity-based ETFs
- exchange-traded funds
- exchange-traded notes
- full replication
- futures-based ETFs
- in-kind exchange
- inverse ETFs
- leveraged ETFs
- physical-based ETFs
- prescribed number of units
- roll yield loss
- rules-based ETFs
- sampling
- satellite holdings
- spot price
- synthetic ETFs
- tracking error
Introduction
- Exchange-traded funds (ETFs) are investment vehicles with characteristics from mutual funds and individual stocks.
- ETFs are professionally managed, either actively or passively.
- Passive management invests in securities tracking specific market indexes.
- Unlike open-end funds, ETF units trade on exchanges.
Mutual Funds Trusts and Mutual Fund Corporations
- ETFs are structured as mutual fund trusts or corporations.
- These structures are regulated by National Instrument (NI) 81-102.
- Individuals licensed as advisors can deal with ETFs under NI 81-102.
- Some types of ETFs include index ETFs and active ETFs.
- Leverage and derivatives use is generally limited.
- Representatives may not be allowed to deal with certain types, such as synthetic, leveraged, inverse, or commodity ETFs.
General Disclosure Requirements
- ETFs use client disclosure documents.
- The general system is outlined in NI 41-101.
- ETF Facts documents are summary documents, patterned after Fund Facts documents used for mutual funds.
Creation and Redemption Process
- A designated broker (market maker or specialist) contracts with an ETF provider.
- ETF units are created or redeemed in blocks from a prescribed number of units.
- The broker buys (or borrows) the shares in the basket.
- The shares are then exchanged for ETF units, and those units are sold as individual units in the open market.
Key Features of Exchange-Traded Funds
- Low cost
- Tradability, liquidity, and continuous price discovery
- Low tracking error
- Tax efficiency
- Transparency
- Low cost diversification
- Targeted exposure
Tradability, Liquidity, and Continuous Price Discovery
- ETFs trade on exchanges throughout the day, like stocks.
- Their liquidity comes from the underlying securities.
- Continuous and transparent pricing occurs.
- This leads to minimizing tracking errors.
Low Tracking Error
- ETF tracking error measures the return difference between the ETF and its underlying index.
- ETFs are designed to closely match their benchmark index, reducing these discrepancies.
- Administrative and trading factors affect tracking error.
- ETF tracking errors are generally lower than mutual funds, due to in-kind creation and redemption process.
Tax Efficiency
- Index-based ETFs typically reduce capital gains realizations.
- Their in-kind creation and redemption minimizes taxable events.
Transparency
- ETF providers are required to disclose holdings frequently, typically daily for broad indexes.
- This transparency aids comparisons with underlying benchmarks.
Low Cost Diversification
- ETFs provide widespread portfolio diversification (many stocks, bonds, and market segments).
- This is achieved at lower costs than traditional mutual funds.
- Low costs are attributed to exchange trading, which reduces record-keeping and other operational expenses.
Targeted Exposure
- ETFs allow investors to access assets previously inaccessible.
- These may include specific sectors or asset classes.
- ETFs facilitate specialized investment strategies.
Types of Exchange-Traded Funds
- Standard (index-based): replicate an index.
- Rules-based (smart beta): follow alternative rules.
- Active: managed by portfolio managers similar to mutual funds.
- Synthetic: utilize derivatives.
- Leveraged: aim for multiple returns against the reference.
- Inverse: aim for multiple returns in the opposite direction.
- Commodity: invest in physical or futures commodity contracts, or equity-based.
- Covered call: employ covered call options strategies.
Risks of Investing in Exchange-Traded Funds
- Tracking error risk: ETF returns may differ from underlying index returns.
- Concentration risk: portfolios heavily weighted to a few securities.
- Liquidity risk (especially with fixed income): availability for trading when needed.
- Cash drag: ETFs that are not fully invested may experience performance lag due to not having all funds invested in holdings.
- Composition of ETF Risk: the ETF may use differing weighting methodologies causing performance differences from a standard index
- Risk related to securities lending: ETF issuer's credit risk affects security value (especially with synthetic ETFs).
- Currency risk: ETFs holding non-Canadian investments are subjected to currency fluctuations.
Comparing ETFs and Mutual Funds
- ETFs are typically passive and more transparent than mutual funds.
- ETFs usually have lower costs and lower tracking errors than mutual funds.
Taxation of Investors in Exchange-Traded Funds
- Investors in ETFs are taxed on realized gains.
- Tax implications from distributions, including dividends, capital gains, and non-taxable distributions.
Other Related Products
- Mutual funds of ETFs: hold a portfolio of ETFs.
- Exchange-traded notes (ETNs): debt obligations from institutions backing returns matching an index.
Investment Strategies Using Exchange-Traded Funds
- Core and satellite portfolio construction.
- Rebalancing.
- Tactical asset allocation.
- Cash management.
- Exposure to hard-to-access markets.
- Tax loss harvesting.
Tips for Trading Exchange-Traded Funds
- Use limit orders.
- For large trades, execute portions at a time.
- Avoid trading during the closing of underlying market hours.
- Be cautious regarding corporate actions and news impacting underlying assets, as this can impact returns
More Complex Roles of ETFs (Investment Strategies)
- Core and satellite portfolio construction
- Rebalancing portfolios
- Tactical asset allocation
- Cash management strategies
- Targeted exposure to hard-to-access markets
- Tax-loss harvesting
Exchange-Traded Notes (ETNs)
- Debt instruments issued by banks, backing performance of an index or benchmark
- May have credit risk
- Subject to call or early redemption risk
- Not considered investment funds
Studying That Suits You
Use AI to generate personalized quizzes and flashcards to suit your learning preferences.
Related Documents
Description
This quiz covers the key aspects of Exchange-Traded Funds (ETFs), including their regulatory structures, types, and distinctive features. You'll also explore the risks affiliated with investing in ETFs and how they compare to mutual funds. Perfect for those looking to enhance their understanding of ETFs and investment strategies.
