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Last
month, we had an overview of the Recognia
Technical Analysis Tool. With the following article, gain insights on Exchange Traded Funds
(ETF's), and discover a new way to invest.
Like the famous utility tool, exchange traded funds are reliable, versatile
and offer good value for money. Indirectly, they also share a little
bit of history. The Swiss Army Knife’s beginning can be traced
back to 1884 when Victorinox was founded. Although it would be over 100
years before the world’s first successful ETF was born, Canada’s
own TIPS 35, a key ingredient of exchange traded funds, the index, also
began in that year. Charles Henry Dow’s initial stock average,
containing 11 stocks including 9 railroad issues, appeared in the Customer's
Afternoon Letter, a daily financial news bulletin that was the precursor
of The Wall Street Journal.
Twelve years later, the Dow Jones Industrial
Average (DJIA) was first published. Today, of course, the DJIA is one
of the most widely followed barometers of the US market and happens to
have the fourth largest US ETF (DIA: AMEX) tracking it. A mission statement
from Victorinox’s web site, “strive to produce high quality
products that are functional, durable and offer the best value for money”,
could equally apply to the ETF industry today.
An ETF is a hybrid security that trades just like a stock, but behaves
like an index fund. For good reason, much has been written about utilizing
the indexing feature of ETFs when constructing long-term oriented portfolios.
By doing so, investors gain inexpensive access to an investment strategy
that keeps fees (MERs as low as 0.09%) and trading costs low, tax efficiency
high and backed by countless studies, outperforms the median active manager
of the same asset class over most reasonable time periods. Furthermore,
these “listed portfolios” are fully invested at all times,
pure in content, and track their chosen bogey extremely well. These features
make precise asset allocation possible, unarguably the most important
decision for long-term investors. Savvy investors use ETFs to ‘tilt” their
portfolios toward specific sectors as well as in tax loss harvesting
strategies to boost after-tax returns. The breadth of choice, unavailable
until recently and still expanding rapidly, brings most investment mandates
within reach.
The 150 ETFs, listed on North American exchanges and available to Canadian
investors, cover both fixed income and equity asset classes. Barclays
Global Investors currently offers all bond ETFs, iUnits tracking Government
of Canada bonds and iShares offering exposure to both US sovereign and
credit debt. Investors can
access total equity markets on a regional or country basis, own complete
industry sectors or dissect many indexes by capitalization size and growth
or value styles. In other words, complete, well-balanced and diversified
portfolios, customized to suit any investor, can be constructed solely
with ETFs.
Not as much has been written about the stock-like features of exchange
traded funds. This is a shame because ETFs were built to trade, unlike
mutual funds where penalties and restrictions on frequent trading are
imposed. Similar to stocks, ETFs can be traded with market, limit or
stop orders in margin, cash or registered accounts, with the big advantage
of diversification built into that single transaction. Traders can go
long or even short under any market condition and there are currently
77 ETFs with listed put and call options. The biggest misconception concerns
liquidity or the ability to complete a transaction without significantly
moving the market price against you. In fact, ETFs have two levels of
liquidity. The first is the traditional liquidity in the marketplace
and is maintained by market makers or specialists. For example, the i6o
(XIU: TSX) has an “outside market” of 15,000 shares at a
bid/ask spread of 10 cents. At a current price around $48 per share,
that represents a $720,000 transaction. Usually, the i60 will be quoted
inside the obligated market as market participants place their own orders.
The second level of liquidity revolves around the fact that ETFs are
open-ended trusts, like traditional mutual funds. However, unlike mutual
funds, where all investors large and small exchange cash and units, only
large institutional investors create new or redeem existing ETF units “in-kind” by
delivering or receiving the underlying basket of securities in the same
proportion to the index (this fungibility also ensures ETFs trade very
close to fair value due to the arbitrage opportunity). Therefore, and
this is key, it is the liquidity of the securities that comprise the
index that determines the ultimate liquidity of the ETF, since more units
can be assembled by simply delivering the appropriate basket. To illustrate,
while the iShares DJ US Healthcare Sector Index Fund (IYH: AMEX) often
trades less than $5 million per day, suggesting limited liquidity, the
176 stocks in the index averages $6.9 billion per day, displaying ample
liquidity.
Not only do ETF investors and traders co-exist in
harmony, having both types of market participants makes ETFs all the
more efficient. Investors help boost the overall supply and traders increase
the traditional liquidity allowing for better pricing for all market
participants when they do wish to transact. Active investors can employ
ETFs to quickly transition a portion or an entire portfolio into or out
of the market. Trading and hedging strategies are countless, whether
relying on fundamental, seasonal or technical analysis techniques. Of
course, the diversified nature of the ETF will not be lost on anyone
who has seen a strategy fail as a perennial blue chip disintegrates before
their very eyes. Exchange trade funds are efficient, versatile and powerful
investment tools that will enhance any investor’s portfolio.
Interested in learning more about Exchange Traded
Funds? Sign-up for one of our on-site seminars on Exchange Traded Funds
coming up this month with Guest Speaker, Mr. Bobby Eng from Barclays
Global Investors. Seminars take place in Montreal, Quebec City, Ottawa
and Toronto.
Click here for a list of dates and to register.
| N.B.
This bulletin is offered for information purposes only. Investments
must meet each investor's objectives. Disnat does not issue any recommendation
about a product or give out any opinion on the nature, suitability
or potential value of an investment or of any trading strategy. |
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