As look-alike ETFs abound, so do questions

If that brand new exchange-traded fund looks remarkably familiar, you're not hallucinating: It probably is.

Look-alike ETFs are mushrooming as competition for investors heats up. "ETF providers are tripping over one another," said John De Goey, vice-president and investment adviser with Burgeonvest Bick Securities in Toronto. "We have quite enough ETFs, but I think this is a battle for market share."

Investors could end up benefiting from the competition, provided they understand the nuances of each product.

That, however, can be a challenge. In November, for instance, both AlphaPro Management Inc. and BlackRock Asset Management Ltd. launched ETFs that invest in preferred shares, joining Claymore Investments Inc., which has long offered a similar product.

How do you decide what to buy in such cases? Here are five things to consider when sifting through the more than 150 ETFs now listed in Canada.

Look under the hood

Most ETFs track some kind of index, but not all indexes are the same. There are indexes that weigh stocks according to their market capitalization, and indexes that hold all stocks in equal weights.

Then there are fundamental indexes that decide which stocks to buy on the basis of factors such as sales, earnings, book value, cash flow and dividends. And some commodity ETFs have different structures, investing in physical bullion or tracking futures contracts, as opposed to a stock index.

Investors need to understand how ETFs are constructed because the performance of funds with similar names can vary, said John Gabriel, an ETF strategist at Morningstar Inc.

For instance, financial industry stocks represent 36 per cent of the Claymore S&P/TSX Canadian Dividend ETF, but 60 per cent of the iShares Dow Jones Canada Select Dividend ETF. Investors may think they have a diversified portfolio with the iShares ETF, but could be risking over-concentration in a single sector, especially if they already own a lot of financial securities, Mr. Gabriel warned.

There are other differences, too. The Claymore ETF looks for companies with a history of raising dividends, while the iShares ETF ranks the highest dividend-yielding stocks, Mr. Gabriel said. "But dividends can be cut. Higher-yielding stocks are usually in distress," he said. As a result, investors in these two similar-sounding ETFs could end up with very different results.

You get what you don't pay for

All things being equal, cheaper is better because fees eat away at returns over time.

"In the words of John Bogle [founder of index giant Vanguard] you get what you don't pay for," said Mr. De Goey.

One possible exception to the low-fee rule is the cost of protecting yourself against foreign currency fluctuations. Some foreign ETFs hedge their foreign currency exposure to Canadian dollars, but there is an additional cost for this service.

For example, the fee for the hedged iShares S&P 500 ETF is 0.24 per cent versus its unhedged U.S. listed iShares S&P 500 ETF at 0.09 per cent. "If you prefer the hedge, then pay the extra 15 basis points," Mr. De Goey said.

Different ETFs are for different folks

Investors need to decide whether they are traders or long-term investors.

Traders who jump in and out of ETFs frequently should choose the ones with higher trading volumes and more assets to get the best price, said Mr. Gabriel. "You want to look at the bid-ask spread. In its simplest terms, it represents the cost to get in and out of a fund. If an ETF has more assets, the bid-ask spread is tighter."

In contrast, long-term investors should focus on finding ETFs with the lowest fees because higher costs reduce returns over time, he said.

Some ETF payouts can be more frequent than others

Investors who need a regular stream of income should check out an ETF's dividend distribution policy to see whether payouts are monthly or quarterly, said Mr. De Goey. People who lack a financial cushion may prefer the more frequent monthly payments.

Not every ETF provider allows regular contributions and withdrawals

Some investors may want to make regular contributions to an ETF through a pre-authorized chequing plan, or withdraw cash through a systematic withdrawal plan. Claymore is the only provider so far that offers these services, which charge a fee on the first transaction.

"Claymore is trying to make their ETFs look and feel like mutual funds," which many investors are more familiar with, Mr. De Goey said.

Similar sounding ETFs can produce different results