Exchange-Traded Funds versus Mutual Funds

[Pages:2]With fees as low as 0.10%, ETFs are giving mutual funds a run for their money.

Exchange-Traded Funds versus Mutual Funds

New low-cost ETFs are giving mutual funds a run for their money

It seems there is a bit of a pricing war going on right now with respect to investment fees in Canada. More specifically the Exchange-Traded fund companies have become very aggressive with their pricing ? in some cases offering core ETFs with management fees as low as 0.10%.

How are Mutual Fund companies to compete with fees this low? The first thing that would come to my mind would be performance. One would hope through active management a mutual fund manager would be able to earn his or her keep ? in other words, make up for the fees through better performance.

Unfortunately this has not been the case, as the data consistently shows that over the long-term most mutual funds underperform their benchmarks. The S&P Dow Jones Index versus Active scorecard provides the proof. In a nutshell SPIVA keeps score ? comparing the ongoing returns of stock market indices versus those of comparable mutual funds.

Consider the most recent SPIVA Canada scorecard comparing returns to mid2013. Of particular interest to me (being a dividend-focused investor) is the Canadian Dividend and Income Equity category, in which the performance of mutual funds that focus on Canadian dividend-paying stocks is compared with the performance of the S&P/TSX Canadian Dividend Aristocrats Total Return Index. According to the 2013 report 58.62% of mutual funds in this category outperformed the index over a 1-year period. However, over a 3-year period the number drops to 3.13%. And if we go back 5 years the number drops to 0. It's hard to believe, but the numbers don't lie: not a single mutual fund in the Canadian Dividend and Income Equity category has managed to beat its benchmark over a 5-year period.

On the other hand, mutual fund companies deserve credit for developing some innovative approaches to tax management. The use of certain classes of mutual funds can sometimes result in meaningful tax savings, as well as the ability to avoid claw-backs of retirement benefits such as OAS and the GIS. These savings will often outweigh the extra costs of mutual funds. I also believe that fixed income is an area where a fund manager can add value. As such I often will use funds to fill out the bond allocation of a portfolio.

What I find most interesting about the ETF versus mutual fund debate is that despite higher fees and lower returns, Canadian mutual funds still outsell ETFs by a better than 15 to 1 margin! It seems perplexing, but really isn't that difficult to explain. It all comes down to marketing. In addition to being profitable, most Canadian mutual funds are backed by Canada's largest and most profitable financial institutions ? the Big 5 banks. With branches in every community, as well as lots of money available for advertising, they have an advantage when it comes to getting their message out to potential investors.

Personally I believe that both ETFs and mutual funds have their place. But I also believe that on balance Canadian investors are over-invested in mutual funds, and under-invested in ETFs. In many cases it would be worthwhile to have a closer look at the various options.

For more on this topic and where ETFs might fit into your portfolio feel free to call Jim at 250-752-8184, or email jim.grant@raymondjames.ca.

Jim Grant, CFP (Certified Financial Planner) is a Financial Advisor with Raymond James Ltd (RJL). This article is for information only. Securities are offered through Raymond James Ltd., member Canadian Investment Protection Fund. Insurance and estate planning offered through Raymond James Financial Planning Ltd., not member CIPF.

For more information feel free to call Jim at 250-752-8184, or email at jim.grant@raymondjames.ca. and/or visit jimgrant.ca

This newsletter has been prepared by Jim Grant and expresses the opinions of the authors and not necessarily those of Raymond James Ltd. (RJL). Statistics and factual data and other information in this newsletter are from sources RJL believes to be reliable but their accuracy cannot be guaranteed. It is for information purposes only and is not to be construed as an offer or solicitation for the sale or purchase of securities. This newsletter is intended for distribution only in those jurisdictions where RJL and the author are registered. Securities-related products and services are offered through Raymond James Ltd., Member-Canadian Investor Protection Fund. Insurance products and services are offered through Raymond James Financial Planning Ltd., which is not a Member-Canadian Investor Protection Fund.

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