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Earlier this year, exchange-traded funds celebrated 25 years of offering low-fee, diversified investment options to Canadians. The anniversary marks the inception of the world's first incarnation of an exchange traded fund, or ETF – the iUnits S&P/TSE 60 Index Participation Fund launched in Canada in March of 1990.
Since then, the popularity of ETFs has grown. They track broad indexes as well as highly specialized ones. The global ETF market grew by 17 per cent in 2014 to more than $3-trillion (U.S.), according to the fund-research firm ETFGI LLP, and in Canada, ETFs account for about $87-billion in assets under management.
Yet small retail investors are just getting started, says Alan Fustey, portfolio manager with Index Wealth Management in Winnipeg.
"Because the mutual fund industry is so much larger in Canada, ETFs haven't gotten much of a foothold with smaller investors except for the last three to five years," he says.
Still, investors are coming around. What are they putting their money into? Here are the top five ETFs by market size on the TSX:
1. iShares S&P/TSX 60 ETF (XIU), $9.6-billion under management as of Sept. 29
Often referred to as the "grandaddy of ETFs," the fund known as XIU has been available from iShares since the late 1990s, but it evolved out of the aforementioned ground-breaking iUnits fund. As a result it has had a big head start on other ETFs in Canada in accumulating assets, and today it accounts for about 11 per cent of the assets under management of the entire Canadian ETF market.
Its popularity is also the result of what it offers, says Tyler Mordy, president and chief investment officer with Forstrong Global Asset Management in Toronto.
It provides exposure to Canada's 60 largest publicly traded companies, Mr. Mordy says, and it has a management expense ratio (MER) of 0.18 per cent, which is inexpensive compared with similar mutual funds, which typically charge 2 per cent or more.
Yet the iShares offering is more costly than other similar ETFs. XIU's most direct competitor is the Horizons S&P/TSX 60 Index ETF, "which tracks the same underlying index, but it uses a tax-efficient total return swap structure to obtain exposure," Mr. Mordy says. Its MER is 0.03 per cent.
2. iShares Core S&P 500 Index ETF, Canadian dollar hedged (XSP), $2.7-billion under management
Offering broad-based exposure to the U.S. market, this fund tracks the S&P 500 index with a MER of 0.23 per cent while hedging the Canadian dollar. Although its hedging strategy helps reduce currency losses when the Canadian dollar rises against the U.S. greenback, it can act as a considerable drag on performance when the loonie falls in value, as it has in the past year, says portfolio manager Graham Westmacott of PWL Capital in Waterloo, Ont.
"In contrast, Canadian investors who have held unhedged exposure to the U.S. market have done very well both from a combination of growth in the U.S. market and the rise of the U.S. dollar against the Canadian dollar," Mr. Westmacott says.
3. BMO S&P 500 ETF (ZSP), $2.3-billion under management
This fund is among the ETFs that would have outperformed fund No. 2 above in the past year because its currency exposure is unhedged. Although it is still popular, the fund had net redemptions of $27-million in August.
"What you're likely seeing is people are feeling they've done well without hedging and that the Canadian dollar has gone as low as it's going to, so they're taking their gains and going elsewhere," Mr. Westmacott says of the fund, which has a MER of 0.13 per cent.
Yet investors considering moving from unhedged ETFs to hedged ones to neutralize the risk of the Canadian dollar increasing in value should think twice.
"No one has come up with a good predictive model for currencies, so this idea of moving from an unhedged ETF into a hedged version according to your view of the direction of currencies is likely to be as much a losing proposition as it is a winning one," he says.
4. iShares 1-5 Year Laddered Corporate Bond Index ETF (CBO), $2.2-billion under management
Providing exposure to Canada's short-term corporate bond market, this iShares offering uses a laddered strategy to moderate the effects of rising and falling interest rates by continually rolling maturing bonds into new ones with five years to maturity.
"The logic is it protects you in declining-rate environments because at least some of the portfolio is locked in for the longer term," Mr. Fustey says. The opposite is true also: "When interest rates increase, you've got 20 per cent of your bonds maturing," so you can then capitalize on higher yields.
While the fund provides diversified exposure to the Canadian corporate bond market, one of its drawbacks is cost, Mr. Mordy says. "With a MER of 0.28 per cent, CBO is a fair bit more expensive than competing short-term Canadian corporate bond ETFs that do not employ a laddering methodology but have similar overall maturity, duration, sector and credit quality profiles."
5. iShares Canadian Short Term Bond Index ETF (XSB), $2.17-billion under management
This ETF tracks the FTSE TMX Canada Short Term Bond Index, which is composed of liquid, short-term Canadian investment-grade corporate and government bonds. Part of its popularity can be attributed to it being the first to market. Launched in November of 2000, it has had more time to accumulate assets than its competitors.
Additionally, with Canadian interest rates hitting multidecade lows, investors have gravitated to this ETF because the market value of its shorter-duration bond holdings will be less negatively affected than those with longer maturities when interest rates rise, something that many believe is imminent.
With a MER of 0.28 per cent, this fund is pricey compared with other ETFs offering non-laddered strategies. Among them is Vanguard's Canadian Short-Term Bond Index ETF (VSB) with a MER of 0.15 per cent.
A final word
Mr. Westmacott points out that while the popularity of these five ETFs is in part a validation of them providing low-cost, diversified exposure to the Canadian and U.S. markets, they capture only a small portion of the investment universe.
"This list is totally devoid of international equities outside the U.S., and it is very heavy on large-cap equities [large companies] with no small-caps at all," he says. "So you certainly can't say, 'I'm going to build a portfolio of ETFs based on those with the most assets.'"
A previous version of this story misstated the MER for the Horizons S&P/TSX 60 Index ETF. Its MER is 0.03 per cent.