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moneysense.ca, 14/01/07
Disadvantages of ETFs
Patrick McKeough, editor of The Successful Investor stock newsletter, points out some of the disadvantages of ETFs in his column in The Financial Post last week. He writes:
The problem is that ETFs’ convenience and low cost works just as well in facilitating dumb moves as smart ones.
The disadvantages that Mr. McKeough points out are:
- Ordinary investors cannot partake in arbitrage opportunities by exchanging blocks of ETF shares for their underlying portfolio or vice-versa.
- Too many new ETFs are being introduced to track specific market sectors or sub-indices, making ETFs a profit centre for sponsoring financial institutions.
- Financial advisors who construct ETF portfolios for clients charge fees and commissions that make it as expensive to own ETFs as actively managed funds.
As a fan of ETFs, I don’t think the first two disadvantages are a big deal. I have no interest in arbitrage opportunities and I simply ignore the vast majority of new ETFs. I actually think competition in ETFs is a good thing: For instance, investors can now get exposure to emerging markets using the Vanguard Emerging Market ETF (VWO), which is much cheaper than the competing ETF (EEM).
The final disadvantage that Mr. McKeough points out (discussed by Jonathan Chevreau in his blog) is a valid one but even for investors who pay 1% of their assets in ongoing fees, ETFs are a good deal when compared to mutual fund investors who end up paying more than 2.5% in fees. Or, investors could just set up a passive portfolio, spend less than hour every year to rebalance and come out ahead of most other investors.
moneysense.ca, 14/01/07
I haven’t been a fan of traditional ETF, although I have tried index funds before. What I had been a fan of in the past are the ETFs which are structured as income trusts. These have been as diverse as the CNV.UN (an income trust holding Convertible Bonds) and FC.UN (an income trust holding commercial mortgages). It is interesting to see that most of these income trusts haven’t fallen very far. It seems as though other unitholders in them feel the way that I do – that in 4 yrs time they can be fairly easily changed to a conventional ETF.
i agree. re #2: if you stick with tried and true ETFs like iShares you should be fine. There’s a whole bunch of new ETFs that have been created lately that are more like mutual funds and have higher MERs. It’s pretty ridiculous if you ask me.
The only problem to put money to American ETF is currency-risk, so Canadian ETF probably more prefferable.
Another caveat: if you invest small amounts at a time in an ETF( 1000$ for example) , you will have to pay a brokerage fee which could be 2% of the amount for a 20$ fee which most small investors pay in regular brokerage accounts). I would think that a good alternative would be to store the money into a no load mutual fund (good quality and low MER) and then move the money to an ETF once a critical amount is reached (5000$?).
What do you think? Does that make any sense?
Of course, ETFs are not suitable for small amounts. Folks investing a small initial amount or investing small sums regularly should consider TD eFunds.
I’m glad we agree
My actual question is: does it make sense to store money in a no load/low cost mutual fund only until you have enough to a buy a ETF? In your TD eFund example, why would someone move out of there into an ETF?
ETFs are cheaper to own, so it definitely makes sense to sell the fund and buy the equivalent ETF.
Let’s take the XBB as an example. The MER is 0.25%. The equivalent eFund charges 0.48%. When does it make sense to sell the eFund and buy the ETF? I would shoot for spending 0.5% in buying commissions or $4000 if you are paying $20 (I am ignoring selling because I am hoping to hold for a long time).
The ONLY time that I would advocate anybody buying a mutual fund is when their investment portfolio is small. The mutual fund then allows that investor to remain diversified as they work to put more money away.
When your portfolio starts to get large (let’s use 100K as an example), then a 2% MER means that you’re paying somebody $2000 a year to do what? Hold shares of extremely liquid large cap stocks like banks, insurance companies and REITs for you? If it’s in a retirement account and your retirement is 20 yrs away, then $2000 a year is $40,000 that you gave to some money manager. Just buy those individual stocks for a one time brokerage fee and hold onto those stocks for decades and then put that extra $40,000 in YOUR pocket!
My biggest peeve about mutual funds is their lack of transparency. The reason why I liked the income trust structure for what is essentially an ETF is because they report their financials using traditional balance sheets and cash flow statements. Traditional funds only reports holdings and fees. A lot of the fees are hidden and you have no idea what transactions were made by the fund during the previous quarter.
Speaking of competition in the ETF market. An article in Canadian Business recently noted the introduction of two new ETF’s in Canada.
The funds, managed by BetaPro Management allow investors to leverage a bullish or bearish opinion on the TSX 60.
Just what I wanted to hear,the pro,s & con,s The best I have heard. THANKS ! Now I can look for an ETF with lots of green in it ?
[...] Canadian Capitalist discusses some disadvantages of ETFs [...]
A stock picker news letter writer is not going to like ETF’s….bad for the bottom line, using the time lag of a news letter , can make anyone look good, just ask Sy Harding….time your alerts just right…money in the bank
Just an up date…over 200 etf’s in Canada now…the down side now! Advisor’s get a front end comish on some of these etf’s…an don’t tell