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Made in Canada: TSX’s Long-Term Relationship with ETFs


By Gary Knight, Vice President, Trading, TSX Markets
This article was originally featured in the July 2013 issue of
Canadian ETF Watch
.

The Exchange Traded Fund (ETF) has deep roots in Canada as an alternative method of investing. In fact, ETFs are a made-in-Canada story.

The world’s first successful exchange-traded, index-linked product was listed on Toronto Stock Exchange (TSX) in 1990. Since then, popularity of the Canadian ETF marketplace has grown rapidly and its assets along with it, particularly since the early 2000s.

Five years ago, the value of ETF assets amounted to only 2% of mutual fund assets; today, that number has grown to more than 6%. To put that growth trajectory in perspective, 2012 was a record year in Canada, with the largest ever annual ETF inflows of $12 billion.

Rapid growth of the ETF industry is expected to continue worldwide. In 2011, a report by McKinsey & Co. showed that the global ETF market is a powerful, disruptive force that is poised to expand significantly as the industry enters a new phase in its evolution.

Investors continue to seek greater diversity and flexibility in their investment vehicles, as well as cost effective, tax efficient and low-volatility investment choices, and TSX is committed to help bring these products to market.

A Canadian Innovation

TSX is home to Canada’s ETFs. ETF providers in our marketplace offer innovative investment opportunities that allow investors to diversify their portfolios while maintaining flexibility in trading that is similar to stocks.

There is growth and vibrancy in the Canadian ETF marketplace. Currently, there are more than 270 Canadian-domiciled ETFs listed on TSX, which offer a lot of choice to interested investors. Just a few short years ago, that number was less than 50.

The widespread adoption of this modern investment vehicle in Canada has resulted in ETF assets under management reaching nearly $60 billion. In a rapidly evolving environment, ETFs are quickly capturing investor attention.

This article is primarily focused on Canadian-domiciled ETFs. However, it is worth mentioning that TSX also lists Exchange Traded Notes (ETNs) and Exchange Traded Receipts (ETRs).

Canadian ETF Marketplace

ETF products listed on TSX reflect unique investor needs and diverse investment strategies. Choosing an ETF may seem challenging at first; however, looking at your options from a wider perspective can help during the selection process.

Generally speaking, ETFs fall into three broad groupings: passively managed, actively managed and screened. The different groups of ETFs respond to various investment styles and criteria of investors.

TSX lists a diverse range of ETFs – from the plain vanilla to the more complex. These ETFs provide exposure to a wide variety of industry sectors and asset classes, including Canadian and international equities, fixed income, commodities and currencies. This diversity provides investors with abundant choice in accessing both domestic and global markets.

To help you choose what type of ETF best suits your investment objectives, consider starting by using TMXmoney.com’s online screening tool (tmxmoney.com/etfscreener) to conveniently search for ETFs by asset class, region, style, size, sector or provider.

ETFs: “Listed on TSX”

Here’s a look at a variety of ETF products listed on TSX and grouped by investment objectives.

Passive Broad Equity ETFs

The simplest ETF is the broad equity ETF that passively tracks the performance of a broad market index. For example, iShares S&P/TSX 60 Index Fund (TSX:XIU) invests in the constituent issuers of the S&P/TSX* 60 Index, which is made up of 60 of the largest, by market capitalization, and most liquid securities listed on TSX.

Access to Dividends

In today’s low interest rate environment, investors are increasingly looking for ways to generate income. One way to accomplish this is by accessing dividends. Fortunately, there are a number of ETFs available to help investors meet this goal.

First Trust Portfolios Canada, Canada’s newest ETF provider, recently entered the marketplace with the launch of three dividend funds.

  • First Trust AlphaDex Canadian Dividend Plus ETF (TSX:FDY);
  • First Trust AlphaDex U.S. Dividend Plus ETF (CAD-Hedged) (TSX:FUD); and
  • First Trust AlphaDex Emerging Market Dividend ETF (CAD-Hedged) (TSX:FDE)

These geographically diverse funds use a rules-based methodology to provide exposure to dividend stocks.

Another income generating strategy gaining popularity is the covered call strategy. Using this approach, covered call options are written on the underlying securities, and premiums are earned from the option writing. These ETFs often have exposure to a target sector, and here are two examples of such funds:

  • BMO Covered Call Canadian Banks ETF (TSX:ZWB) provides exposure to a portfolio of Canadian banks while earning call option premiums; and
  • First Asset Tech Giants Covered Call ETF (TSX:TXF) is an equally weighted portfolio of the 25 largest technology companies by market capitalization listed on a North American stock exchange and earning call option premiums.
Reduced Volatility

There are a number of strategies that attempt to either reduce or minimize investor exposure to volatility. For example, BMO’s low volatility strategy allows investors to target a specific portfolio risk level that is lower than the broad market. This strategy uses low beta stocks to insulate investments from market volatility.

Here’s a look at two ETFs that can help reduce market volatility arising from domestic and global factors:

  • BMO Low Volatility Canadian Equity ETF (TSX:ZLB) selects the 40 lowest beta stocks from the 100 largest and most liquid securities in Canada; and
  • BMO Low Volatility US Equity ETF (TSX:ZLU, TSX:ZLU.U) selects the 100 least market sensitive stocks from a universe of U.S. large cap stocks, and can be traded in Canadian or U.S. dollars.
Fixed Income

There is much discussion in the industry about the risks associated with a potential rise in interest rates. To help mitigate these risks, there are several fixed income strategies available to ETF investors that provide some flexibility in fixed income investment.

Laddering strategies are used to manage interest rate risk. They provide exposure to bonds of staggered maturities or successive maturity dates along the yield curve. Listed below are two ETFs that provide a laddered approach:

  • iShares 1-5 Year Laddered Government Bond Index Fund (TSX:CLF) provides exposure to a diversified government bond portfolio with laddered maturity levels from one to five years; and
  • iShares 1-5 Year Laddered Corporate Bond Index Fund (TSX:CBO) provides exposure to a diversified corporate bond portfolio with staggered maturity levels from one to five years.

Investors can also look into using a barbell strategy; that is, investing at the short and long ends of the yield curve. This strategy allocates equally between short term and long term bonds, and in the current environment allows for higher income from long term bonds while the short term exposure provides a counterbalance of safety and flexibility. Here are three examples of ETFs that offer a barbell strategy:

  • First Asset DEX All Canada Bond Barbell Index ETF (TSX:AXF) consists of Canadian government and corporate bonds.
  • First Asset DEX Corporate Bond Barbell Index ETF (TSX:KXF) consists of only corporate bonds; and
  • First Asset DEX Government Bond Barbell Index ETF (TSX:GXF) consists of only government bonds.

All three products above are comprised of short maturity bonds with one to two years to maturity, as well as long maturity bonds with ten to 20 years to maturity.

A tactical bond strategy is another fixed income approach that uses a combination of strategic and tactical allocation strategies. For example, the PowerShares Tactical Bond ETF (TSX:PTB) provides exposure to mainly government, corporate and real return bonds. It makes tactical shifts based on economic conditions and opportunities. Primarily, it uses an overall diversification strategy that employs asset classes that have historically performed well in different economic cycles (e.g. recessionary, non-inflationary and inflationary).

There are also opportunities for diversification through products like the PowerShares Senior Loan (CAD-Hedged) Index ETF (TSX:BKL) which provides exposure to senior loans, including leveraged loans, syndicated loans, bank loans and floating rate loans. These typically fall below investment-grade quality, but offer enhanced yields. Their low duration nature could help an investor reduce their risk of rises in interest rates.

Finally, there are also opportunities to target maturities through ETFs. For instance, RBC Target Maturity Corporate Bond ETFs (such as TSX:RQA and TSX:RQI) are fixed income ETFs maturing in successive years ranging from 2013 to 2021. Each fund tracks an index that maintains a portfolio of Canadian investment-grade corporate bonds structured to mature in the same year as the ETF itself.

Global and Emerging Markets

ETFs can also provide exposure to global and emerging markets. These internationally-focused funds are used to broaden an investor’s exposure in an increasingly interconnected, global economy. Here’s a look at a couple of examples of ETFs that provide access to international markets:

  • The Vanguard FTSE Emerging Markets Index ETF (TSX:VEE) tracks the FTSE® Emerging Index, which includes securities of companies located in 22 emerging markets around the world.
  • The BMO MSCI Emerging Market Index ETF (TSX:ZEM) tracks the MSCI® Emerging Markets Index, which includes securities of companies located in 21 emerging market countries.

A big distinction between the two examples above is that the BMO product classifies South Korea as an emerging market, whereas the Vanguard product, which excludes this country, considers it a developed market. This demonstrates the potential variance in geographic exposures of international ETFs.

Commodity Exposure

On the whole, there are three main ways to gain exposure to commodities:

  • Physically-backed ETFs;
  • ETFs that track futures contracts; and
  • ETFs that track indices comprised of securities of resource producers and exploration companies.

Here are several examples of ETF products that provide exposure to commodities:

  • iShares Gold Bullion Fund (TSX:CGL) is backed by physical gold. Similarly, iShares Silver Bullion Fund (TSX:SVR) consists of silver bullion assets. Both funds seek to replicate the performance of bullion prices.
  • iShares Broad Commodity Index Fund (CAD-Hedged) (TSX:CBR) generally consists of futures for crude oil, natural gas, corn, soybean, hogs, cotton and other commodities.
  • Horizons BetaPro NYMEX Natural Gas Bull Plus ETF (TSX:HNU) seeks daily investment results equal to twice the daily performance of the NYMEX Natural Gas futures contract.
  • Horizons BetaPro NYMEX Natural Gas Bear Plus ETF (TSX:HND) seeks daily investment results equal to twice the inverse daily performance of the NYMEX Natural Gas futures contract.
  • iShares S&P/TSX Capped Materials Index Fund (TSX:XMA) invests in the constituent issuers of the S&P/TSX* Capped Materials Index.
Alternative Strategies

Individual and institutional investors seek alternative investment opportunities, and many are looking to managed futures as a solution. Basically, through a managed futures strategy, an investor further diversifies his or her portfolio by searching for alternative or non-traditional investment opportunities.

Horizons Auspice Managed Futures Index ETF (TSX:HMF) is designed to provide exposure – long or short – to assets such as energy, metals, agriculture, currencies and interest rates. By and large, this fund uses tactical strategies designed to capture up or down trends while reducing risk in a variety of economic environments. In effect, this ETF’s objective is to deliver portfolio diversification by using asset classes with historically low correlations to stocks and bonds.

Hedging Currency Exposure

Sometimes investors want exposure to the U.S. dollar and, at other times, they want to reduce their exposure to greenbacks. With Canadian ETFs, you have choice. For example, the Vanguard S&P 500 Index ETF (TSX:VFV) and the Vanguard S&P 500 Index ETF (CAD-Hedged) (TSX:VSP) both provide exposure to large U.S. companies by tracking the performance of the S&P 500 Index. However, in the latter fund, U.S. dollar exposure is hedged back to the Canadian dollar.

Actively Managed ETFs

Globally, many ETFs are still of the passive, index-tracking genre. Yet, in recent years, there has been an increasing focus on actively managed ETFs.

Earlier in this article, we referred to a report by McKinsey & Co. regarding the rapid global growth of ETFs — that report also notes, in a conclusive way, that the active ETF market in the U.S. is growing at a rapid pace. Specifically, the report argues that active ETFs in the U.S. will reach $1 trillion in assets under management by 2021. Canada has also been on a growth trajectory.

Aside from the earlier mentioned ETF that uses a managed futures strategy (TSX:HMF), there are additional active ETFs available to investors in Canada. One such example is the Horizons Active Preferred Share ETF (TSX:HPR). This fund invests mainly in preferred shares of North American companies, which are selected based on the sub-advisor’s criteria and analysis of the company’s industry and growth prospects.

Canadian ETF Marketplace: Still Evolving

The growth and proliferation of ETF products since their introduction more than 20 years ago has been nothing short of remarkable. To be sure, the ETF market is evolving and this made-in-Canada story is still being written. As the industry enters a new phase in its evolution, TSX is committed to continue helping to bring new products to market.


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