Over the last few years, ETFs (short for exchange-traded funds) have become an attractive addition to the portfolios of many individual investors and institutions. According to the Canadian ETF Association, total Canadian-listed ETFs under management crossed the $200 billion mark at the end of 2019. Still, market penetration in Canada is only 7 to 8 per cent, says Pat Dunwoody, executive director of the CETFA. The reasons are often based on myths about ETFs, not facts. This article debunks three of the most popular ETF myths, so you can feel more confident about including ETFs in your investment mix.
Do ETFs beat the market?
Myth: ETFs never beat the market.
Many investors believe that funds must be actively managed to achieve benchmark-beating performance. As a result, they believe using ETFs, which tend to be passively managed, means you’ll never do better than the index. That’s a myth.
Fact: Active management of ETFs has a goal of outperforming the market.
First, there are now a number of “active ETFs” whose goal is to outperform the market, rather than track it, at a lower cost than traditional actively managed investment options such as mutual funds and stocks. Second, the performance of a single ETF in a portfolio isn’t necessarily the key to outperforming the market. Portfolio managers who use a core-satellite approach with ETFs are actively managing passive investments to maximize performance and minimize volatility. This increases the likelihood that overall portfolio returns will be better than the indices the specific ETFs track.
I'm worried about liquidity with ETFs
Myth: ETFs aren’t liquid enough.
Liquidity is an important aspect of risk management. Unfortunately, there’s a misperception that during a market downturn or selling wave, you won’t be able to find a buyer for your ETFs.
Fact: ETFs can be more liquid than stocks.
The reality is that ETFs can be more liquid than stocks for two reasons. First, ETF shares can be issued or withdrawn on the secondary market as required. (The secondary market is where trading in shares that already exist takes place). Second, ETFs can access liquidity through the primary market, where ETF sponsors, dealers and market makers create the ETFs. As a result, ETFs tend to be less vulnerable to price fluctuations than stocks are, even when an ETF has a small volume of assets under management or a low daily trading volume.
ETFs don't meet my complex investment needs
Myth: ETFs are too simplistic.
Many investors are familiar with having advisors who build portfolios of stocks. Stock picking is seen as a sophisticated service that adds value, while passively managed ETFs are misunderstood as simple investments that don’t require third-party expertise.
Fact: The simplicity of ETFs is their strategic advantage.
The fact is, a portfolio manager can build a portfolio of ETFs that are chosen according to a sophisticated strategy just the same as a portfolio manager can choose a portfolio of stocks. Today’s ETFs can give investors access to almost any market, sector, industry, commodity, currency or investment style. And because ETFs are relatively simple, a skilled portfolio manager can very efficiently and at low cost tactically rotate to get exposure to markets that are performing well and reduce exposure to those that aren’t.
Given every investor’s desire to manage risk and maximize return, you’re right to be suspicious about the new kid on the investment block. But don’t let myths about performance, liquidity and simplicity keep you from including ETFs in your investment portfolio. The truth is, ETFs in combination can beat the market. They’re just as liquid as most stocks. And their simplicity helps you meet your objectives for asset mix, geographical sector, diversification and risk at a lower cost.
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