Because they provide convenient exposure to bonds, stocks, and other investment assets, exchange-traded funds (ETF) are a great way to diversify one’s portfolio. For Canadians seeking international exposure, ETFs can also work — as long as they’re used right.
“We always tell people, don’t buy an ETF blindly that would have a lot of commodity exposure, because if you’re trying to diversify away from Canada, for example, which is very commodity-centric, you don’t want to go out and buy a Brazilian oil company or a Russian mine,” Stephane Rochon, managing director and head of private client strategy with BMO Nesbitt Burns
, told the Globe and Mail
Rochon noted strong consumer and industrial exposure in European markets; healthcare, technology, and industrial opportunities abound in the US.
Diversification is also valuable if one is trying to escape sector volatility. “[The TSX capped composite index is] 12% in basic materials. There’s a lot of volatility there,” said Tim Morton, senior vice-president and portfolio manager with TD Wealth
Morton’s team experimented with a portfolio that, aside from having a TSX composite-exposed ETF, also included three other ETFs with separate exposures to the S&P 500, NASDAQ 100, and the Russell 2000. The four ETFs were given equal weight.
The portfolio’s basic materials exposure was just 4.3%. Weightings in finance and energy, meanwhile, were at 14.5% and 6%, respectively; in the TSX, the finance sector has 32% weight, while energy is at 21%.
Unlike mutual funds, ETFs trade throughout the day, allowing investors to trade more quickly in reaction to international news. Morton also noted that ETFs can be currency-hedged or currency-exposed, so investors can decide to not take on the additional risk associated with currency differences.
But a lot of ETFs offer passive, index-based exposure. Unlike actively managed portfolios, where the weights of poor-performing sectors can be calibrated downward, ETFs will remain locked to the index’s weightings regardless of its components’ performance — potentially exposing investors to the brunt of hits sustained by specific areas. “Also, because so much money is flowing into ETFs, it can exacerbate market moves,” Rochon told the Globe and Mail
For those and other reasons, there are cases when actively managed pools like mutual funds can be more beneficial than ETFs. “We’ve done some studies on this when it comes to global equities at large, but especially with emerging markets, active managers can reduce downside risk,” Morton said.
“With distinct geographies, demographics, economies and currencies, international markets can be complex, so active managers can often add value selecting and trading securities in these markets,” said Alice Fang, vice-president of investment solutions at Scotia Wealth Management
Because of that, she said, some mutual funds may be worth their incremental cost over their ETF counterparts. “[But] not all ETFs are priced the same and not all actively managed mutual funds are equally well managed, so seeking advice from investment professionals or doing research can be informative,” Fang said.
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