What the heck is an ETF? Portfolio Manager Neville Joanes explains

What is an ETF? WealthBar explains.Today, we wanted to talk about ETFs, or Exchange-Traded Funds. WealthBar invests exclusively in ETF’s. We had a chat with our portfolio manager, Neville Joanes about how ETF’s work and why they are so popular.

Neville, in layman’s terms, what is an ETF?

As you might know, stocks are units in a company that are bought and sold on an exchange – if you want shares in Apple, you can buy shares in Apple.

An ETF performs the same as a company, like Apple, on the stock exchange, except it is not a company, it is a overarching fund that holds shares from many companies.

Right, so what does that look like?

An ETF can hold shares in a broad spectrum of companies, or choose to curate specific stocks to make a narrow ETF. Think of it like an art collector who is a fan of the surrealist era. The collector curates a collection of works by Picasso and Dali to exhibit at a gallery. The ETF is the gallery and the chosen stocks are the paintings.

For example, the BMO Equal Weighted REIT ETF is a narrow ETF with shares from a handful of Canadian Real Estate Investment Trusts. Alternatively, the S&P 500 Core ETF holds shares in equity assets in industries like healthcare, technology, financial services, and more. This type of ETF is more like an art museum that collects all types of art.

From the investor’s perspective, when you buy a share of the ETF, you get a small part of each of the stocks in the ETF.

So, going back to the art analogy, if you buy into the collection, you get a piece of each painting.

Yeah, but you don’t want to do that to art.

OK. So why should people be into ETFs?

One of the major advantages of purchasing an ETF share is diversity. Having a diverse portfolio is important to some investors because if one stock performs poorly, another one might perform well, counterbalancing the loss.

So, if you have a tech based ETF that includes Apple and Apple stocks decrease by five per cent, but the rest of the stocks swing upward, than the impact of the Apple stock will have less effect on the entirety of the ETF.

Using the painting analogy. If the Picasso in your collection suddenly loses value, but the Frida Kahlo increases in value, your overall collection doesn’t suffer to the same degree as it would if your collection was only Picasso’s.

Right.

You’d be in trouble then.

Exactly.

Why else?

Most ETFs are passive, which means they essentially track the market. There isn’t a middle man – called an active manager – trying to come up with creative ways to beat the market. This along with how they operate makes them more efficient and less costly than, for example, a mutual fund. The market does well, the ETF does well. Simple. Furthermore, only a small percentage of active managers consistently outperform the market, so going with an ETF makes sense for most investors.

Sounds pretty sound.

There are risks with an ETF, just like another other stock or mutual fund. You’re not guaranteed to make money, but what it will give you is access to a broad spectrum of the market for a lower fee.



Neville Joanes. Portfolio Manager @ WealthBar
Neville Joanes is the Portfolio Manager & CCO at WealthBar. Neville oversees portfolio management and investment operations, ensuring that clients’ portfolios meet their objectives. He is dedicated to his goal of always delivering the best investment management to our clients. Neville is also a CFA® charter holder.

4 Comments

Janet Tease

Can you explain the difference between a “hedged” and “unhedged” ETF.
Thanks.

Reply
Chris Nicola

Hi Janet, generally a hedged ETF will be hedged against changes in currency prices. So an ETF that holds US equities that is “hedged” to the Canadian dollar would hold a hedge against the Canadian dollar that would prevent it from fluctuating with the value of the Canadian dollar relative to the US dollar. Generally speaking we don’t use hedged ETFs for two reasons. One is that there is a cost to managing the hedged positions, the other is that holding global equities positions also exposes us to global currencies which adds to the diversification of the portfolio. If we hedged everything to remove currency fluctuations it would mean we are only holding investments in one currency in the market.

Reply
Jennifer

You said “Most ETFs are passive, which means they essentially track the market. There isn’t a middle man – called an active manager – trying to come up with creative ways to beat the market. This along with how they operate makes them more efficient and less costly than, for example, a mutual fund. The market does well, the ETF does well.”
If “the market does well, the ETF does well”, then if the market does poorly, does the whole ETF also do poorly?

Reply
Denny Hollick

Generally speaking, that’s the case. In the short term, it’s true we’ll see market dips – but in the long-term the market has always gone up. By being a passive investor and investing for the long-term, we ride out those dips, and eventually you’ll end up on the other end better off than where you started. It’s important that you’re invested in the right amount of risk to tolerate your investment time horizon – the shorter your outlook, the less risk you should take on.

Reply

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