Understanding ETFs

While ETFs have been around for more than 30 years, not everyone understands what they are and how they work.

Simple definition

An ETF is a basket of securities—including stocks, bonds, commodities, currencies, options or a mix of assets—that is offered in units and traded on an exchange:

  • Each ETF unit represents a proportional interest in the pooled assets
  • ETF units can be bought and sold whenever the exchange is open
  • Investors buy ETF units through a brokerage account—like the purchase of stock shares
  • Investors can perform various stock-like strategies, including selling short, buying on margin and placing stop-loss orders

What is an ETF?

  • Pooled investment
  • Traded intra-day on an exchange
  • Bought and sold through a broker
 

Stocks and mutual funds have similarities and differences compared to ETFs

 

Similar but different

Overall, an ETF is the same as a stock. However, there are several differences, particularly relating to pricing and liquidity:

  Stock ETF
Trading Trading takes place on an exchange
Order types Market and limit orders apply
Pricing Prices are driven by supply and demand among investors in the marketplace

If there are more buyers than sellers, share prices rise to reflect higher demand—and the reverse also applies

The authorized participant calculates the ETF portfolio’s current value throughout the day to determine bid and ask prices for the ETF on the secondary market

The primary market reflects the NAV of the underlying ETF at which the authorized participant creates and redeems ETF units

The secondary market (exchange) reflects the prices that are driven by supply and demand among investors in the marketplace
Liquidity

There are a set number of shares available in the marketplace

Liquidity largely reflects the average volume of shares trading on the market

ETFs provide the authorized participant with the ability to create and redeem units based on investor demand, ensuring alignment of the ETF unit bid/ask price and the underlying NAV of the fund

The liquidity of an ETF is driven by the liquidity of individual securities within the portfolio

An ETF also resembles a mutual fund in many respects except for one key characteristic—the ability to trade ETF units on an exchange:

  Mutual fund ETF
Basket of securities
Passively managed
Actively managed
Bought and sold through brokers
Continuously traded on a stock exchange
Intra-day, real-time value
Subject to daily price fluctuations
Ability to perform stock-like strategies*

* Including short selling, buying on margin and placing stop-loss orders

Oh, Canada

Canada has been a global innovator in the development of ETFs. The first ETF in the world—an equity fund—was launched on the Toronto Stock Exchange in 1990.1 The inaugural bond and Bitcoin ETFs were also launched on Canadian soil in 20002 and 20213respectively.

1990
Canada flag icon		 2000
Canada flag icon		 2021
Canada flag icon
First ETF First bond ETF First Bitcoin ETF

Record of growth

ETFs have been around for some time. However, their popularity really took off after the global financial crisis in 2008, when investors started to switch from actively-managed funds and relatively poor returns to passive funds and inherently low fees.

$12T

Total ETF
assets
globally

17%

10-year annual
average growth
in ETF assets

10%

10-year annual
average growth
in # of ETFs

The global ETF industry reached a new milestone at the end of 2023, including assets of $11.6 trillion and 11,869 different funds. This represents a compounded annual growth rate in assets of 17.1% over the past 10 years and 9.5% based on the number of funds. During 2023, ETF assets increased by 25.6% as the number of funds grew by 6.8%.4

Year-end ETF assets*/^ # of ETFs^
2006 603 829
2007 856 1,424
2008 774 2,093
2009 1,157 2,550
2010 1,478 3,404
2011 1,526 4,091
2012 1,951 4,481
2013 2,402 4,775
2014 2,787 5,193
2015 2,997 5,751
2016 3,552 6,186
2017 4,838 6,681
2018 4,815 7,681
2019 6,361 7,958
2020 7,986 8,440
2021 10,262 9,879
2022 9,260 11,117
2023 11,634 11,869

* USD billions
^ Including ETFs and related exchange-traded products (ETPs)

Net inflows continued to grow at high levels in 2023, reaching a year-end total of $974.9 billion—the second-highest after record inflows of $1.3 trillion in 2021. December also represented the 55th month of consecutive net inflows.

Regionally, ETFs with North American mandates have the largest footprint based on assets under management:5

North America: 65% icon

North America

Global: 14% icon

Global

Emerging markets: 9% icon

Emerging markets

Asia-Pacific: 7% icon

Asia-Pacific

Europe: 5% icon

Europe

Passive by design, but…

ETFs have traditionally focused on passive investment tools. While the market has evolved over the past decade to include actively-managed ETF options, passive funds continue to rule from an assets under management perspective. In Canada, for example, approximately two-thirds of ETF assets (64.9%) are passively managed.6

What is the difference between the two management styles? Passively-managed ETFs provide broad market exposure by tracking to an index that targets a particular country, region, sector or theme (e.g., S&P 500 index); they represent one of the first types of ETFs and, as mentioned, continue to comprise the majority of ETF assets. On the other hand, actively-managed ETFs seek a specific investment objective (e.g., exceed the return on an index) through a professional investment management team that makes ongoing decisions regarding portfolio construction; they focus on a variety of markets and sectors, delivering investment returns that do not track an index.

 

Diversification. Transparency.  Liquidity.

 

The why

What are the reasons for an investor to choose ETFs?  The key advantages of investing in an ETF structure include:

  • Diversification: ETFs provide investors with an efficient way to diversify a portfolio, without having to select individual securities
  • Transparency: ETFs generally disclose their full portfolios via public websites daily, including what securities the fund holds, how it’s performing and what it costs
  • Liquidity: ETFs can be bought and sold on an exchange at market price whenever the market is open
  • Tax efficiency: Index funds tend to have minimal turnover; since investors sell their shares on an exchange, there is no requirement for the investment manager to sell the underlying assets and potentially incur a capital gain
  • Cost: ETFs generally offer lower expense ratios since most are passively managed or “no-load" funds; however, the ETF market has evolved in recent years to include a broad choice of ETFs with a range of fees (see section on Innovation)

The why not

Despite the significant advantages of ETFs, there are also a number of inherent risks of which investors need to be aware:7

  • Market risk: ETFs are reflective of their underlying investments; the value of these investments is directly correlated with the value of the ETF and subject to fluctuation
  • Tax risk: The tax treatment of investments may vary, particularly with non-traditional investments
  • Fund closure risk: ETF investors may incur costs associated with fund liquidations; however, broadly speaking, ETF investors don't lose their investment when an ETF closes
  • Trading risk: Similar to stocks, an ETF has a spread; it is important to understand an ETF's liquidity and to trade with stop-loss orders as appropriate
  • Price risk: ETFs normally trade close to their net asset value (NAV/unit) and any variations would be due to exceptional circumstances

As investors move beyond traditional stock and bond ETFs, they need to familiarize themselves with the workings of these non-traditional investments.

 

There is an inverse relationship between age and interest in ETFs

 

Youth at the forefront

Having grown up just before the 2008 financial crisis, millennials tend to be “fee conscious” when it comes to financial services. Younger investors overall are typically tech savvy with a preference for “do-it-yourself” online tools in seeking out investments. It, therefore, shouldn’t be surprising that ETFs are enjoying increasing popularity among these age groups.

According to a study conducted by Logica Research on behalf of Charles Schwab,8 millennials have invested more of their portfolios in ETFs than other generations and a steady rate of growth is anticipated over the coming years. Millennial respondents hold more than 40% of their assets in ETFs, compared to a third for Gen X and less than 20% for baby boomers. Millennials expect that nearly half of their investments will be ETFs in five years compared to 40% for Gen X and 26% for boomers.

  Total Millennials Gen X Boomers
Average % of investments in ETFs today 33% 41% 33% 19%
Average % of investments in ETFs in five years 40% 48% 40% 26%

A similar study by the Australian Securities Exchange (ASX)9 found that Next Gen investors—people aged 18 to 24 years—are drawn to ETFs more than shares. The study indicates that Next Gens are least likely to hold Australian shares directly (36% compared to 77% of retirees), but they are most likely to invest in ETFs (20% versus 7% of retirees).

  18 to 24 years Retirees
Hold shares directly 36% 77%
Hold ETFs 20% 7%

Image of young adolescents laughing and posing together for a photo

Further confirming age differences in ETF ownership, a report published by the Investment Company Institute and Strategic Business Insights10 found that, while 7% of US households reported recent or ongoing ownership of ETFs, 21% of ETF-owning households were headed by a person younger than 40 years old, compared with 15% of retail mutual fund households. In addition:

  • 36% of ETF households were headed by someone aged 60 or older, compared with 52% of retail mutual fund households

  • ETF households tend to be more highly educated, with 66% reporting at least one college degree, compared with 56% of retail mutual fund households and 34% of all US households

  • ETF households generally have higher incomes, although households across all income groups report ETF ownership.
  ETF
households		 Retail mutual
fund households
Headed by a person younger than 40 years old 21% 15%
Headed by a person 60 years or older 36% 52%

1 25th Anniversary of the first ETF in Canada, ETFGI, March 9, 2015
2 History of ETFs, Vanguard, 2022
3 Canadian Regulators Approve World’s First Bitcoin ETF for Individual Investors, EKB, March 14, 2021
4 ETFGI reports that assets invested in the global ETFs industry reached a new milestone at the end of 2023, ETFGI, January 16, 2024
5 EPFR Data Reports Total Global ETF Assets Exceed $10 Trillion, EPFR, Informa Financial Intelligence, November 11, 2021
6 ETF and Index Funds Report—Canada, Investor Economics, Q2 2022
7 What risks are there in ETFs, etf.com
8 ETFs and Beyond, Charles Schwab, September 2022
9 ASX Australian Investor Study 2020, Australian Securities Exchange, September 2020
10 A Close Look at ETF Households Investment Company Institute and Strategic Business Insights, October 1, 2018