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Debunking ETF myths
12/18/2018 8:29:36 AM
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By Fund Library News Wire  | Thursday, February 15, 2018



By Kevin Gopaul, Head of Quantitative Strategies and ETFs, CIO Canada, Head of BMO Global Asset Management

Exchange Traded Funds have become the foundation of clients’ investment portfolios, and like any new product, while many benefits are understood, there are misconceptions that have entered into client conversations.

Myth #1: ETFs are just like stocks

ETFs trade on an exchange like a stock; however, unlike a stock, which has a limited number of shares available for sale or purchase, an ETF is an open-ended fund that can create new units based on demand. This means that clients can buy larger blocks of units without worrying about running through the order book, while clients who buy smaller blocks will benefit through offsetting client orders. Market makers will continually offer new shares and will create new units when needed.

Myth #2: Stocks and funds outperform ETFs

Active management has an important part to play in financial markets and can deliver meaningful outperformance; the challenge for active managers is to do so consistently over time. Active managers typically target improved risk-adjusted returns by selecting high quality stocks. ETFs can outperform when the entire market lifts off or when higher fees and adverse stock selection impacts active managers.

Myth #3: ETFs aren’t liquid

ETF liquidity begins with the underlying portfolio. Where ETFs are based on harder-to-trade strategies, they will then have less liquidity. An ETF adds liquidity through exchange trading, where as an ETF matures, more buyers and sellers meet on the exchange and the ETF develops more liquidity than its underlying portfolio. This is particularly beneficial in narrower asset classes and fixed income, two areas with liquidity challenges.

Myth #4: ETFs are riskier than stocks and funds

Warnings that ETFs will cause instability, particularly in less liquid areas like bonds, is a consistent refrain. Instead, I would turn this on its head. While in fixed income markets, reforms have impacted liquidity and execution, ETFs add liquidity because they hold a diversified portfolio and because most of the trading on mature ETFs does not touch the underlying portfolio. As an example, on our BMO High Yield Bond US Corporate Bond Hedged to CAD Index ETF (TSX: ZHY), a harder-to-access asset class, only 17% of the exchange trades in 2016 resulted in underlying portfolio trades. This percentage would only be lower on larger U.S.-listed ETFs.

Myth #5: ETFs cause market crashes

An important caveat to exchange trading is that just like a stock, an ETF is subject to the integrity of the markets – in other words, if there is a market event, or large moves in investor sentiment, we should expect ETFs to move with the market. ETFs are priced based on their underlying portfolios, not the other way around. The assumption that since ETFs impacted market stability as they became prominent, then, doesn’t pass the smell test.

At the end of the day, ETFs are an important innovation in financial markets, and allow more investors to access different asset classes, and to have better trade execution on more diversified portfolios. Just like anything else, understanding how they work is critical to having a good client experience.

Kevin Gopaul is Head of Quantitative Strategies and ETFs, CIO Canada, Head of BMO Global Asset Management. He is also Chair of the Canadian ETF Association. This article first appeared in the Fall 2017 issue of Your Guide to ETF Investing, published by Brights Roberts Inc. Reprinted with permission.

Notes and Disclaimer

© 2018 by Fund Library. All rights reserved. Reproduction in whole or in part by any means without prior written permission is prohibited.

BMO Global Asset Management is a brand name that comprises BMO Asset Management Inc., BMO Investments Inc., BMO Asset Management Corp. and BMO’s specialized investment management firms.

BMO ETFs are managed and administered by BMO Asset Management Inc., an investment fund manager and portfolio manager and separate legal entity from the Bank of Montreal. Commissions, management fees, and expenses all may be associated with investments in exchange traded funds. Please read the prospectus before investing. Exchange traded funds are not guaranteed, their values change frequently, and past performance may not be repeated.

®BMO (M-bar roundel symbol) is a registered trade-mark of Bank of Montreal.

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