Browse Analysis of Managed and Structured Products

19.1 Introduction

This section provides a comprehensive introduction to Exchange-Traded Funds (ETFs), covering their key features, structure, types of management, and how they differ from traditional mutual funds.

Understanding Exchange-Traded Funds (ETFs)

An Exchange-Traded Fund (ETF) is an investment vehicle that amalgamates characteristics of both mutual funds and individual stocks. They are typically structured as open-end mutual fund trusts and are regulated similar to mutual funds under the National Instrument 81-102. Certain ETFs are also subject to National Instrument 81-104, which regulates funds that involve commodities and derivatives either individually or in combination.

  • National Instrument 81-102: Governs mutual funds in Canada including ETFs.
  • National Instrument 81-104: Regulates commodity and derivatives funds.

Management Styles of ETFs

Passive Management

Passive management in ETFs aims to create a portfolio that tracks specific market indices such as the S&P/TSX 60 Index or the S&P 500 Index. The majority of ETFs are passively managed, reflecting the performance of their benchmark indices. Some Common Market Indices Tracked by Passive ETFs:

  • S&P/TSX 60 Index: Represents 60 of the largest companies listed on the Toronto Stock Exchange.
  • S&P 500 Index: Comprises 500 of the largest U.S. companies.

Active Management

Although most ETFs are passively managed, there is a growing number of actively managed ETFs. These funds aim to outperform their benchmark indices through various investment strategies practiced by professional portfolio managers.

Trading ETFs: An Overview

Unlike traditional open-end mutual funds, units of an ETF are listed and traded on a stock exchange or an alternative trading system much like individual stocks. This can be revolutionary as it allows ETFs to be bought on margin and sold short. Additionally, some ETFs have options trading available, which adds a layer of flexibility and strategy for investors.

Key Advantages of Trading ETFs

  • Liquidity: ETFs can be traded throughout the trading day at market price, unlike mutual funds which are traded at the end of the day’s Net Asset Value (NAV).
  • Flexibility: ETFs offer the option to trade with margin and sell short.
  • Accessibility: Purchasable through regular brokerage accounts without needing specialized fund accounts.
  • Diverse Strategy Implementation: Options trading allows for varied risk management and leverage strategies.

Frequently Asked Questions (FAQs)

What are the major differences between ETFs and mutual funds?

ETFs trade on stock exchanges like individual stocks, while mutual funds are usually bought and sold at the end of the trading day at the closing NAV. ETFs generally offer higher liquidity and real-time trading capabilities.

Can ETFs be actively managed?

Yes, while majority of ETFs are passively managed, tracking an index, a growing number of them are actively managed involving active buying and selling of assets by the fund manager.

What is the regulatory framework governing ETFs in Canada?

In Canada, ETFs are regulated under the National Instrument 81-102 which governs mutual funds. ETFs involving commodities and derivatives also fall under National Instrument 81-104.

Key Takeaways

  • ETFs combine features of mutual funds and individual stocks.
  • They can be both passively and actively managed, although passive management tracking market indices is more common.
  • ETFs are traded on stock exchanges, allowing real-time trading, margin buying, and short selling.
  • ETFs offer benefits of liquidity, flexibility, and diverse strategy options.

Glossary of Terms

  • ETFs (Exchange-Traded Funds): Investment funds traded on stock exchanges, similar to stocks, but offering diversified portfolios akin to mutual funds.
  • Passive Management: Investment strategy aiming to replicate the performance of a specific index.
  • Active Management: Strategy where a portfolio manager actively makes investment decisions to outperform the market index.
  • National Instrument 81-102: Regulations overseeing mutual funds in Canada, including ETFs.
  • National Instrument 81-104: Regulations governing funds involving commodities and derivatives.
  • Liquidity: Ease with which an asset can be bought or sold in the market without affecting its price.
  • NAV (Net Asset Value): The total value of a fund’s assets minus its liabilities, usually calculated at the end of each trading day.
  • Margin Buying: Purchasing securities by borrowing a portion of the purchase cost from the broker.
  • Short Selling: Strategy where a trader sells a security they don’t own, anticipating a decline in value.

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## What is an exchange-traded fund (ETF)? - [ ] A type of bond - [x] An investment vehicle that combines features from mutual funds and individual stocks - [ ] A savings account - [ ] A type of insurance policy > **Explanation:** An exchange-traded fund is an investment vehicle that combines some features from mutual funds and some from individual stocks. They are typically structured as open-end mutual fund trusts and are regulated like any other mutual funds. ## How are exchange-traded funds (ETFs) typically managed? - [ ] Always actively managed - [ ] Always passively managed - [x] Either actively or passively - [ ] Always self-directed by the investor > **Explanation:** Exchange-traded funds are professionally managed products that can be either actively or passively managed. Most are passively managed but the number of actively managed ETFs is increasing. ## Under which regulation are exchange-traded funds generally subject to? - [ ] National Instrument 81-104 exclusively - [x] National Instrument 81-102 - [ ] National Instrument 45-106 - [ ] National Instrument 31-103 > **Explanation:** Exchange-traded funds are subject to National Instrument 81-102, which regulates most mutual funds. ## What does passive management of an ETF involve? - [ ] Frequent buying and selling of assets - [ ] Managing the fund based on real-time market signals - [x] Constructing a portfolio that tracks specific market indexes - [ ] Investing exclusively in commodities > **Explanation:** Passive management constructs a portfolio of securities that track specific market indexes, such as the S&P/TSX 60 Index or the S&P 500 Index. ## Where are units of exchange-traded fund trusts listed and traded? - [ ] Only on foreign exchanges - [ ] Exclusively on mutual fund marketplaces - [x] On a stock exchange or alternative trading system - [ ] Exclusively through over-the-counter platforms > **Explanation:** Units of exchange-traded fund trusts are listed and traded on a stock exchange or an alternative trading system, similar to individual stocks. ## Can exchange-traded funds (ETFs) be bought on margin? - [ ] No - [x] Yes - [ ] Only for institutional investors - [ ] Only for mutual funds > **Explanation:** Since ETFs are traded on an exchange, they can be bought on margin similar to individual stocks. ## What is one feature that ETFs share with individual stocks? - [ ] They are not professionally managed - [ ] They cannot be sold short - [x] They can be bought on margin and sold short - [ ] They are not regulated > **Explanation:** ETFs can be bought on margin and sold short, just like individual stocks. ## Which regulatory instrument may apply to ETFs that use commodities and derivatives? - [ ] National Instrument 31-103 - [ ] National Instrument 45-106 - [ ] National Instrument 81-102 only - [x] National Instrument 81-104 > **Explanation:** ETFs that use commodities and derivatives may also be subject to National Instrument 81-104. ## What is an actively managed exchange-traded fund? - [ ] A fund that always tracks a specific index - [ ] A fund managed by individual investors - [ ] A fund that does not change its holdings - [x] A fund where the manager makes decisions about buying and selling securities > **Explanation:** An actively managed ETF is where the manager makes decisions about buying and selling securities based on their assessment of the market. ## Why might the number of actively managed ETFs be increasing? - [ ] Because passive management is becoming obsolete - [ ] To avoid regulation - [ ] Because they cannot be traded on exchanges - [x] Due to increased interest in achieving better returns than the index > **Explanation:** The number of actively managed ETFs is increasing due to the growing interest in achieving better returns than those offered by passively managed index-tracking funds.

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Tuesday, July 23, 2024