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What is an ETF: Separating Myths from Reality

Exchange-traded funds (ETFs) were first introduced to Canadian investors nearly 30 years ago, with traditional ETFs being passively managed, simply mirroring a particular index.

The ETF market has matured since then, offering a wide variety of options from active to passive and covering all asset classes from equity to fixed income, alternatives and portfolio solutions.

Yet, despite the growth of ETFs, they continue to be a misunderstood investment.

Here we dispel the top four myths we’ve encountered:

Myth #1 – All ETFs passively track an index

Fact: As of June 2018, 222 of the 612 ETFs offered on the Canadian market were actively managed – only 24 fewer funds than the passive, market cap-weighted index category.*

Active ETFs also ended Q2 of this year with a three-year compound annual growth rate (CAGR) of 43%. That’s brought its share of assets under management to $31 billion or 19.8% of total ETF assets (see chart).

Myth #2 – ETFs are just for traders and not long-term investing

Fact: As the spectrum of ETFs available has evolved, so have the reasons investors are choosing them.

ETFs deliver the benefits of trading like individual stocks but many ETF investors will buy-and-hold ETFs for the long-term as core holdings in a portfolio or as a satellite (tactical allocation) holding in a portfolio to complete desired asset allocation.

Myth #3 – The average daily traded volume of an ETF exclusively determines its liquidity

Fact: The true liquidity of an ETF is measured by the liquidity of its underlying securities and allows for significant trade orders without having an impact on price of the ETF itself.

ETFs have three layers of liquidity:

  1. Primary markets creation & redemption process

  2. Continuous price discovery by market makers

  3. Secondary market buyers and sellers

Myth #4 – ETFs are not for income investors since they don’t pay dividends

Fact: Many ETFs do distribute income to investors. Considering that an ETF holds a diversified basket of the individual stocks or bonds, its behaviour will follow that of its underlying holdings including the dividend or coupon payments.

ETFs have the ability to generate and distribute:

  1. Income (Dividend + Interest)

  2. Capital Gains (Primarily when a rebalance occurs)

  3. ROC (Fixed Payer ETFs)


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