The surging popularity of exchange-traded funds (ETFs) has many investors wondering whether these investments are suitable for retirement savings plans.
The management expense ratios (MERs) of ETFs tend to be low, making them an attractive option from an investment cost standpoint. But as with any type of investment, many factors must be considered in order to build an effective portfolio.
Like mutual funds, ETFs provide participation in a basket of securities, offering the benefits of diversification and liquidity.
But the ETF takes the evolution of investing to the next level by "securitizing" these diversified baskets of securities and listing them on stock exchanges throughout the world.
This means that investors can buy and sell their fund like any other exchange-listed equity any time markets are open. For most people, however, the challenges of choosing suitable investments and monitoring those investments remains daunting regardless of whether they are using ETFs, mutual funds, or individual securities.
In a global investment environment, where markets are increasingly driven by global macroeconomic factors, the value of expertise in professional investment management is more important than ever before.
It is in the area of professional portfolio management techniques where ETFs have delivered the most value and benefit to the investor.
Where previously much professional analysis would have focused on individual security selection, global macroeconomic analysis and the resulting asset allocation decisions are now seen as the key drivers of portfolio risk and return.
In this context, ETFs can provide the liquidity and affordable access to asset classes that were previously difficult and expensive to access, such as commodities, precious metals, and emerging market fixed income.
Furthermore, the proliferation of ETFs now makes it possible for money managers not only to access market returns at a low cost, but also to fine-tune a portfolio using specialized ETFs such as those focused specifically on one sector or style, say, income generation.
As a result, it is now possible to build a better, more diversified portfolio with as little as $100,000 at less cost than was possible 15 years ago with individual securities. In today's volatile, globally interconnected investment markets, the need for diversification and risk-management has never been more acute.
And for something as important as your RRSP portfolio, it's even more critical to steward capital on a risk-adjusted basis that protects against volatility and losses.
So here are six steps we use to help construct ETF portfolios that meet those criteria:
1. Use global macro allocations to recognize different secular eras.
2. Employ strategic asset-type allocation to establish net risk.
3. Establish broad asset-type diversification to limit strategic risk.
4. Set investment limits for every holding to reduce concentration risk.
5. Utilize pure asset-type index ETFs to limit impact of single-security risk.
6. Probability-weight multiple scenarios to insulate portfolios against future risk.
- Robyn Graham, is vice president and associate portfolio manager of HAHN Investment Stewards. Provided courtesy of Fund Library, owned and operated by Fundata Canada.
This article is the opinion of the author and is not intended as personalized investment advice. Investment vehicles mentioned are not guaranteed and involve risk of loss.