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Building a better portfolio
With the ETF industry steadily evolving, it’s now much easier to create a diversified portfolio made entirely out of these funds
Date: November 10, 2017
When the first exchange-traded fund was introduced 27 years ago, there wasn’t much that retail investors could do with it – it was mostly an institutional-focused product.
As more passive ETFs came to market, it was still difficult to create comprehensive portfolios, as most were just set-it-and-forget-it index-hugging securities.
Now, though, with smart-beta options, actively managed ETFs and a greater range of passive products, investors can create dynamic portfolios without having to pick stocks or mutual funds.
“The industry has grown and seen more innovation,” says Michael Cooke, senior vice-president and head of exchange-traded funds for Mackenzie Investments. “There’s a lot of different ways of achieving investment exposure. There’s a lot more choice.”
There’s good reason to create a portfolio with ETFs, says Mr. Cooke. First, these products are typically less expensive to hold than other types of investments.
Investors are paying closer attention to fees, and they’re managing their cost of investment more than they have in the past.
Certain ETFs are also more transparent than other products, he adds. Investors can see exactly what these funds hold, but there’s also more clarity around transaction data, such as on bid offers and how the ETF’s underlying stocks and bonds are being traded.
Liquidity is key, too. Unlike with mutual funds, which can only be bought or sold at the end of the day, ETFs trade on a stock exchange and can be bought and sold any time markets are open. That gives investors more flexibility, says Mr. Cooke.
“The added benefits of intra-day liquidity, transparency and cost effectiveness are among the reasons why we’re seeing more investors looking into ETFs as portfolio components,” he says.
Creating an ETF portfolio involves balancing different types of products, from a fee and diversification perspective. Most investors are likely familiar with passive ETFs, which are funds that hold the same securities as an index, like the S&P/TSX Composite or the S&P 500. When an index rises or falls, so does the ETF.
Over the last few years, though, the ETF landscape has evolved beyond traditional index-tracking securities. Smart-beta ETFs, for instance, allow investors to invest in strategies that follow an alternative index construction based on a certain style of investing, such as momentum, value, low-volatility and others.
They’re essentially a mix of active and passive investing in that they hold securities based on a pre-determined index, but they’re active in that they consider factors other than just the market capitalization weighting of stocks that a traditional passive index tracks.
These kinds of funds give investors even more flexibility – and that can help them, or their advisors, create portfolios that are more tailored to their specific needs, says Mr. Cooke.
“You can now cater to any type of investment objective,” he says. “If you’re looking for dividends, or if you like value, or if you want to maximize diversification, ETFs can deliver that.”
More recently, companies have started developing actively managed ETFs, which usually come with competitive management fees and can be traded at any time markets are open, like a traditional ETF.
Managers oversee these securities and can pick and choose what goes into the fund. This gives investors yet another way to hone in on a specific area or style and increase diversification.
“An individual or team would have full discretion over the constituent securities that populate the portfolio,” says Mr. Cooke. “The ETF market has just about everything you’re going to need in terms of building blocks to create a diversified portfolio.”
Think like an institution
When it comes to creating a portfolio from ETFs, the first place to start is to think about objectives. What kind of outcomes does the investor want to achieve? It could be growth and outperformance, or maybe there’s a need for dividend income, or they’re closer to retirement and want to minimize volatility.
“Ask yourself what you want to achieve with your own portfolio,” says Mr. Cooke. “Look inward. What are your objectives as an investor?”
The next step is finding a mix of ETFs that can help achieve those goals. Mr. Cooke points out that the largest institutional investors tend to hold a variety of asset classes and management styles.
For an individual, that means own¬ing some passive, smart-beta and actively managed ETFs. It’s not usually good practice to hold just low-volatility products or only value funds, he adds.
Choosing where to allocate money is a personal decision, but consider fees and expertise. If someone wants exposure to the broad Canadian market, then owning a less expensive S&P/TSX Composite Index ETF could make sense.
A diversified investor, though, may also want to own a dividend fund, so a smart-beta option might be added to the mix. And they may want an emerging-market fund, too, for foreign exposure. In that case, a professional manager who understands the often complex emerging-market space – but still works within the more transparent and more liquid ETF structure – could be called for.
No matter the mix, though, creating a diversified portfolio with just ETFs has never been easier. And that’s a good thing for people who want more control over how and where they invest.
“With more ETF options,” says Mr. Cooke, “you can now get better asset allocation and create a better overall portfolio.”
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