Types of ETFs in Canada: A Simple Breakdown

Since ETFs stray from conventional investment, they might cause a headache or two for inexperienced investors. After all, you can’t throw money at something you don’t understand!

But that’s why we’re here – to explain all types of ETFs in Canada, how they work, how you can buy them, and what to expect in the long run. 

Ready? Let’s begin!

Types of ETFs in Canada

There are thousands of exchange-traded funds in Canada to choose from, but there is no one-size-fits-all solution. You need to choose the investment best suited to your budget and risk tolerance, although we can give you all the details you need so you can make an informed decision.

Here is a closer look at the different types of ETFs on the Canadian market.

Market/index ETFs

Most ETFs fall somewhere in the market or index category. These ETFs attempt to track the performance of an index, such as the S&P 500 Index. 

Index-based ETFs aim to earn the return of the market (or a subset of the market) that it wants to replicate, but without the fees. 

These funds generally exhibit less volatility than industry-specific ones and tend to be among the lowest-cost options. However, investors are locked into the performance of the underlying index, so if that underperforms, so will the ETF.  

Some popular market-based ETFs include TSX, IVV, FXI, and EWG. 

Bond ETFs

A type of exchange traded funds in Canada that invests exclusively in bonds is adequately called a bond ETF. These investments hold a portfolio of bonds with different strategies and generally invest in fixed-income securities like corporate bonds. 

Bond ETFs trade on a centralized exchange throughout the day and provide investors with an opportunity to break into the bond market. These investments are more liquid and hold assets with different maturity. 

But bond ETFs might also put your initial investment at risk because they don’t mature like individual bonds and there isn’t a guarantee the amount will be repaid in full. 

Currently, the most prevalent bond ETFs on the Canadian market are XSB, XHB, ZAG, and VSC.

       

Industry/sector ETFs

If there’s a specific industry you want to invest in, consider industry or sector ETFs to trade securities of a certain industry sector. Typically, most investors opt for the energy, biotechnology, or tech industries because these are currently the most profitable. 

What makes these ETFs desirable is the fact that every industry group has multiple indices tracking the industry performance, so investors always have a benchmark and can roughly estimate what to expect from the stocks. 

Unfortunately, many of these types of ETFs have higher fees and offer lower returns, so you should research thoroughly. 

And as a start, you can look into ZGD, VRE, XGD, and XIT. 

Commodity ETFs

For investors breaking into investing in commodities like nickel, individual stocks may prove hard to access. But that’s why commodity ETFs are an excellent alternative. They provide exposure to price fluctuations of raw materials, including agricultural goods, metals, and natural resources.  

But these ETF types can be less transparent and harder to predict. Plus, they typically don’t directly own the assets. Instead, many use derivatives that track the underlying price of the commodity and carry an increased degree of risk.  

Although commodity ETFs considerably diversify your portfolio, be aware of the heightened volatility and make decisions accordingly. 

To get you started, check out FM, HUZ, XEG, and HUC. 

Real Estate ETFs

Real estate ETFs or real estate investment trusts (REIT) invest assets in equity REIT securities and derivatives. Just like other types of ETFs in Canada, most REIT ETFs are passively managed. 

Investing in real estate will provide you with constant income, but with valuations popping up occasionally. Investors receive their profits each year, but they also get money from owning income properties like apartment complexes or hotels. 

Keep in mind that REITs can be “top-heavy” with the largest ones making the most value. Of course, you could still invest in smaller REITs, but you’d be going against the grain. 

As a start, consider investing in HCRE, ZRE, XRE, or RIT.

Currency ETFs

If you want to invest in either a single currency or a basket of currencies, a currency ETF is your go-to. These types of ETFs are pooled investments and provide exposure to foreign exchange currencies. 

This choice will largely depend on your risk tolerance, as derivatives are generally riskier. Ultimately, you should choose a currency ETF if you think the underlying currency will strengthen and you want to hedge your portfolio. 

These funds will give you access to exchange rates in one or more currency pairs, but they may also fluctuate in value for unknown reasons. 

Some of the most popular currency ETFs include DLR, FXE, FXB, and FXA.

Leveraged ETFs

A type of marketable security that uses financial derivatives and debt to increase the returns of underlying indices is a leveraged ETF. What’s interesting about these ETFs is that they track the index in a 2:1 or 3:1 ratio, as opposed to the 1:1 found in other funds. 

Leveraged ETFs have the potential for significant gains that exceed the index and investors can even make money when the market is in decline. 

However, these ETF types can also cause great losses and have higher fees and expense ratios than other funds. Additionally, they’re not long-term investments, so they may not be suitable for everyone. 

Currently, the most prominent leveraged ETFs are HBD, HBU, HED, and HEU.   

Actively-managed ETFs

Although most ETFs are passively managed, there are some on the market that have a portfolio manager adjusting the investments within the fund. In this case, the fund is not being subjected to predetermined rules of index tracking and managers generally aim to beat benchmarks with the help of research and proven strategies. 

Because there is a human in the inner workings of the fund, these ETFs have the potential for higher returns and allow short sales and buying on margin. 

But since they require active management, investors should expect steep management fees compared to other types of ETFs. 

The best actively-managed ETFs on the market include ZWB, PRA, XTR, and VVO. 

How Do ETFs Work?

Now that you know the types of ETFs, it’s prime time to learn what they are in general and how they work in the investing world. 

Exchange traded funds in Canada offer investors an opportunity to invest in a portfolio of opportunities like stocks and bonds. You can think of it like a salad – it’s got different kinds of ingredients (stocks and bonds) in one bowl (the ETF). 

Similar to mutual funds, each ETF unit allows you to buy individual assets in one bulk purchase. But unlike mutual funds, ETFs don’t have a human manager who actively trades stocks in and out of the base. Instead, they have algorithms and are being passively managed.   

ETF units can be bought and sold multiple times per day at a market-determined price just like individual stocks. They’re open-ended and new units are constantly being created while existing ones can be redeemed daily, depending on investor demand. Conversely, individual securities and closed-ended funds only issue a fixed number of units, regardless of demand. 

So, here’s how it all works – the ETF provider scans all current investments on the market, picks their favourites, and bundles them together. Sometimes, the bundles have themes, such as “blockchain technologies” or “robotics and artificial intelligence”, which gets you a slice of all the hot industries and caters to what you’re interested in.

Other times, providers might choose to track a sector of the economy, like healthcare. In any case, once the basket of investments has been created, the provider sells the shares to the public. 

After you’ve bought a share of an ETF, you don’t own the underlying investments, but rather a share of the whole basket. When the entire basket of investments does well, everyone who’s invested will get a portion of the gains in the form of a dividend. 

How to Buy ETFs in Canada?

If you want to buy any of the ETF types available in Canada, you’ll need to get familiarized with choosing and investing beforehand. 

Before commencing, ensure you identify the best ETFs depending on your investment objectives. So don’t shy away from comparing, evaluating, rating, and overviewing prospective ETFs before settling. After all, this can be a long-term investment, so it should suit your needs to a T.  

To buy an ETF, the first thing you should do is open an investing account at any reputable Canadian bank or any of the thousands of stock trading apps and platforms. 

If you don’t have an investment plan yet, make one! 

Think about investing your money in a portfolio that matches your risk profile and don’t bite off more than you can chew. 

And remember that research is your best friend. There are thousands of types of ETFs, but not all of them would benefit you. Since you won’t and shouldn’t buy them all, you’ll need to meticulously research which ones fit your objectives. Upon deciding, you can fund your account.  

Finally, you can place a trade for the ETFs you want to buy and start tracking your investments. 

But if you’re a newbie and this multi-step process seems daunting or overwhelming, you can opt for a robo-advisor that automatically invests your money and ETFs when the time is right. All you need to provide is your risk tolerance and investment objectives and allow the robo-advisor to recommend portfolios that match and go hands-free.  

Pros and Cons of ETFs in Canada

Generally, ETFs are an excellent investment opportunity. But they’re not without faults. 

So if you’re having trouble deciphering whether this mixed blessing is the right investment move, let’s take a walk through the pros and cons. 

Here’s why you should consider investing in exchange-traded funds in Canada:

• Portfolio diversification – one ETF can contain assets from different industries, countries, styles, or market segments, without having to select individual stocks or bonds, which will give your investment portfolio a much-needed boost and expose you to new opportunities. 
• Passive investing – since ETFs don’t have a fund manager, they work on passive investing by tracking a broader range of stocks, and your portfolio is updated regularly to reflect changes in the reference index. 
• Lower fees – as a passive investment, ETFs have much lower expense ratios compared to mutual funds where you pay fees and expenses for management, shareholder accounting, marketing and other services, sales and distribution, etc. 
• Low effort – ETFs don’t require constant active tracking and managing, making them a great source of passive income. This means you can put your feet up and trust that the algorithm is working for your best interest every day. 

But of course, the best cloth may have a moth in it, as is the case with ETFs. Some reasons why you would eschew this investment opportunity include: 

• Difficult to control – since ETFs aren’t limited to one industry or country, investors can’t influence the individual stocks in the ETF’s underlying index, which means that you can’t exclude or include stocks without eliminating or adding an investment in the entire fund.
• Average returns – if you’re looking for investments that can yield high dividends, ETFs might disappoint, as they generally come with less risk and fewer rewards because they commonly track a broader market. 
• Tracking errors – although ETFs mimic the performance of a benchmark index, the difference between the returns of the fund and those of the benchmark index containing the underlying stocks can sometimes be higher than expected which can yield undesirable results. 

Naturally, exchange-traded funds in Canada can be tricky for a new investor. Although these investments are considered one of the safest out there, there’s always room for errors. And since you’re funnelling money, you should understand both sides of the coin clearly. 

Conclusion 

With so many types of ETFs in Canada, it would be next to impossible for anyone not to find something that fits their lifestyle and investment journey. 

Ultimately, you should dedicate an ample amount of time to ferociously research your desired ETFs, determine your risk tolerance and have a clear image of what you would like to achieve with your investment. 

By doing so, you’re swiftly on your way to success. Good luck!