ETFs for your RRSP

Hey there, time traveller!
This article was published 05/02/2022 (1392 days ago), so information in it may no longer be current.

‘What the ETF?’ is a clever phrase uttered in a bank television ad that speaks to these investment vehicles’ growing popularity while at the same time still being unknown quantities to many people.

If you’re thinking, ‘Just what is an ETF?’ it stands for ‘exchange-traded fund.’

Canadians are turning onto them at a record-breaking pace with $53 billion flowing into them in 2021. Despite their rise, we’re not dropping mutual funds, which have higher fees among other differences.

“We keep using superlatives to talk about the success of ETFs with new records set, but a lot of those records are not coming at the expense of the mutual fund industry, which has had itself a record year in 2021,” says Michael Cooke, head of Exchange Traded Funds at Mackenzie Investments.

Cooke is referring to Mackenzie Investments’ Year-End ETF Report, which also revealed the number of ETFs in Canada now listing on exchanges like the Toronto Stock Exchange (TSX) is 1,177 up from 1,010 in 2020.

Cooke’s assessment is spot on. ETFs account for a significant amount of investor dough — about $347 billion last year in assets under management (AUM), Investment Funds Institute of Canada (IFIC) figures show.

The mutual fund market — which has been around much longer and is generally easier to access, offered widely via banks and credit unions — is much bigger. It’s growing too. Last year, dollars invested in Canada in mutual funds exceeded $2 trillion for the first time, up from $1.7 trillion in 2020.

If you’re an investor — as opposed to a saver — chances are you’re investing in mutual funds.

Good for you: any kind of investment strategy done consistently over many years is likely to help you achieve your financial goals, like retirement.

Yet if you’re still thinking ‘what’s an ETF?’ and have money to invest, it’s worth learning about mutual funds’ promising little sister, especially with the RRSP contribution deadline approaching on March 1.

Indeed they’re part of the same family.

Both use fund structures to hold diversified portfolios of stocks, bonds, commodities or sometimes even other mutual funds or ETFs.

But mutual funds are often purchased through your financial institution, with transactions settled at the end of the trading day. ETFs are bought and sold like stocks on exchanges during trading hours through an online brokerage or an advisor.

Another key difference is management expense ratios — MERs. ETFs have significantly less costly MERs. For example RBC’s U.S. Equity Fund (sold through an advisor) has an MER of 1.89 per cent — not bad for a stock-based mutual fund — and a 10-year annualized return of almost 15 per cent (ending Dec. 31) — again, pretty good.

But its comparable benchmark — the S&P 500 index listing the largest 500 publicly traded companies on the New York Stock Exchange — has an annualized return of almost 16.55 per cent over the same span.

Here’s where ETFs show their worth because of their origins, developed in Canada in the 1990s, as tools to capture the performance of indices like the S&P 500.

Rather than paying a manager about two per cent of your assets every year to outperform that index — which is hard to do consistently — you could pay less than a tenth of that MER and largely receive the same return as the index.

For example, the U.S.-listed iShares Core S&P 500 ETF has a 10-year average, annual return of 16.5 per cent. The difference between its return and the S&P 500 and the RBC fund is its MER, which is 0.03 per cent per year. Dollar-wise, if you invested $10,000 over the decade your money would have grown to $44,000 with the ETF versus about $39,000 with the mutual fund.

This illustrates a case long made for ETFs. They often provide superior growth because the additional fee of a mutual fund for expert managers to pick investments is often a drag on investment returns.

More broadly, ETFs’ low cost and instant diversification across entire markets have made them handy building blocks for all investors, including pension fund managers, says Mark Raes, head of ETF and mutual funds at BMO Global Asset Management.

“The ETF market has matured to a point now where you can really feel comfortable building out core allocations in a portfolio.”

Do you want to invest in the biggest stocks in Canada? Just buy an ETF that owns the top 60 largest companies traded on the TSX.

While ETFs make up only about 12 per cent of all investment funds, Raes says their growth rate exceeds mutual funds.

“A lot of conversation is around ETFs catching mutual funds, and the growth rate is certainly — if you look at the longer term trends — higher,” he says.

Then again, he adds, ETFs are growing from a much smaller size over the last decade.

In 2012, ETFs had $56 billion AUM versus $850 billion for mutual funds. Given their growth over 10 years — more than 600 per cent for ETFs, and nearly 250 per cent for mutual funds — demand is strong for both.

Besides offering low-cost diversification and exposure to a total market, ETFs are also a cauldron of innovation. There are ETFs providing exposure to gold, space companies, cryptocurrencies and even ESG (environmental, social and governance) strategies. Canada is again a leader bringing, for example, the first Bitcoin ETFs to market last year.

Another world-first is a pair of carbon-neutral ETFs: Evolve’s CleanBeta ETFs for the TSX 60 and S&P 500.

“We had this ‘lightbulb’ moment about a year ago,” says Evolve’s chief executive officer Raj Lala. “We said, ‘What if we could take traditional indices and apply carbon offsets against the companies within the index, and deliver to investors a carbon-neutral version of the index that they’re already owning?’”

Launched in May, Evolve’s ETFs has had a “slow start,” Lala says, struggling to gain attention in a crowded marketplace.

But like ETFs in general, Evolve’s funds are worth closer examination if you seek low-cost, innovative — in this case carbon neutral — strategies to build wealth for your future.