Today, there are greater investment opportunities available at a lower cost than ever before in what we would call the democratization of personal investing. A significant factor in this trend has been the growing number of ETFs. The first ETF in Canada, iShares S&P/TSX 60 Index ETF (XIU), was launched in 1999, and in less than 25 years the market has ballooned to greater than 1,300 ETFs listed in Canada.
Falling Expense Ratios
The growing availability of ETFs has led to greater price competition amongst the different issuers within Canada. Today, there are more than 40 issuers nationwide offering a broad range of ETF products, including:
- Canadian Equities
- US Equities
- Sector Equities
- Global/International Equities
- Canadian Fixed Income
- US Fixed Income
- Global/international Fixed Income
- Commodities
- Alternative Investments
Understandably, this ever-expanding list of options has put increasing pressure on providers to reconsider expense ratios, especially on passive vehicles. ETFs that simply track an index must compete on cost in order to attract fund flows.
Expense Ratios Explained
An expense ratio encapsulates how much an ETF, or mutual fund, charges as a percentage of average net assets and covers the various costs borne by fund providers including portfolio management, marketing, distribution, administration, and legal fees.
IInvestors can think of the expense ratio as a percentage that they would annually pay in order to invest in that particular ETF.
As mentioned above, increased competition has led to expense ratios falling over time with many now significantly lower than they were just 20 years earlier. This is a meaningful development as expense ratios (while seeming like small figures) can add up very significantly over a long runway of compounding years. In fact, the difference in expenses paid between a 0.5% expense ratio and a 2.5% expense ratio differs by more than 5x over 20 years.
Guide to Picking Low-cost ETFs in Canada
The good news for investors is that there is an extremely high level of transparency when it comes to the expense ratios of ETFs. There is no hiding behind hidden fees for issuers as they are all subject to the same regulation which requires them to fully disclose charges.
In general, passive ETFs will be more inexpensive as compared to active ETFs as they require less oversight from a portfolio manager and have lower trading costs associated with their strategy.
A screening tool such as CBOE’s ETF screener is an effective way of filtering for low-cost ETFs. However, expense ratios are not the only factor that investors should take into consideration.
Other things that investors should look out for are:
- Bid-ask spreads: a bid-ask spread shows the highest price that a buyer is willing to pay, and the lowest cost that a seller is willing to sell at. This gets wider for ETFs that are less actively traded and can result in greater costs.
- Premium/Discount to NAV: the NAV, or net asset value of an ETF, represents the total value of its underlying securities. Market prices of ETFs can deviate from underlying securities and could potentially trade at either a premium or a discount to its NAV. While these generally self-correct over time, an investor purchasing an ETF at a discount to NAV is essentially acquiring the securities at a discount to their market values.
- Trading commissions: This does not relate to the ETFs themselves, however just like buying or selling stocks investors should try to find reliable, low-cost brokers to fill their trades when they are purchasing or selling ETFs in order to minimize overall investing costs.
Data as of May 23, 2023, unless otherwise noted.
This content was originally published by our partners at the Canadian ETF Marketplace.