Over the last several years, the number of Canadian-listed exchange-traded funds (ETFs) has exploded. There are more than 1300 Canadian ETFs to choose from. Despite a multitude of changes to existing ETFs and entrance of new ones, traditional core ETFs, most of which track well-known indexes such as the S&P 500 and S&P/TSX Composite Index, remain a popular choice for investors.
If you look at the actual usage of products, whether by assets under management, annual net sales or traded volumes on the exchange, core is a huge part of how investors and advisors use ETFs in overall portfolio construction. It is the original category in many respects, and still the most widely used.
What are Core ETFs?
Core ETFs offer broad, indexed exposure to an asset class or geographical region and they usually track a popular index. They’re also generally market capitalization-weighted, and they have a broad range of portfolio applications.
Typically, people will build their portfolio with just a handful of ETFs – Canadian, U.S., international, and emerging market equities and bonds.
Also, because the ETF follows an index, it also has some of the lowest fees compared to ETFs that are actively managed.
You can think of core ETFs like buying a reliable family SUV. It will get you there using a safe path, but you can also park it and drive a Ferrari or a Porche if you'd like something more aggressive, as long as you are okay with a few ups and downs. However, the core family SUV will get you there with a smoother ride.
Effective tools for active and passive investors
One of the main reasons why core ETFs continue to garner large inflows is due to their ability to capture broad market performance. Sector, thematic or factor-based funds, like dividends or low-volatility, can experience periods of outperformance and underperformance relative to their broader market benchmark, while core funds simply replicate the market they’re tracking.
Hypothetically, if overall earnings growth averages 7% a year, over 10 years, then as long as the valuation is not too far from average, the odds of capturing that growth are pretty high using core ETFs.
Capturing that growth is a key component for investors and advisors as they plan for the future. While both stock and bond performance has been challenging in 2022, such periods are a good reminder of the importance of a long-term approach. The longer the time horizon an investor has, the better the prediction they can make about future returns. Core portfolios can then really line up with that prediction.
How to use core ETFs in your portfolio
Core ETFs for portfolio diversification
Because of their low cost, core ETFs are a great tool to help advisors tailor portfolios to their clients’ investment objectives. For instance, if you have a selection of 30 individual stocks in your portfolio, you can easily complement these holdings using a core equity ETF that captures sectors and regions not covered by the portfolio. This allows you to add diversification and avoid concentration risk.
Core ETFs for tactical allocation
Likewise, core ETFs make tactical moves easy. If changing interest rates are the concern, you can look to modify your portfolio duration using a core fixed income ETF with a shorter duration. If you are concerned about high stock valuations in certain geographies, you can shift money to other geographies using core funds.
Core ETFs for simplicity
Some core ETFs can be viewed as a pre-built “all-in-one” solution to provide a range of equity and fixed income exposure in one fund. They are a simple and easy way to access broadly diversified mix of investments, while allowing investors to align their risk tolerance and long-term investment goals.
Choose the right core
Take a look at Our Growth Portfolios, Dividend Portfolio, and Fixed Income Portfolio to get an example. All of these portfolios have some core ETFs to add diversification.
Some of our favourite ETFs include iShares Core MSCI Canadian Quality ETF (XDIV). This one provides Canadians a way to hold stocks that have an above average dividend yield that also still has ample opportunity for capital gains growth.
You should also consider Dynamic Active US Dividend ETF (DXU) because they focuses on large cap companies, with some exposure to mid-cap companies, and are profitable, well-financed and attractively valued. This fund seeks to differentiate the portfolio from the S&P 500 Index.
TD Active Global Growth ETF (TGGR) seeks to achieve long-term capital growth by investing in equity securities of issuers from anywhere in the world, primarily issuers with strong, sustainable franchises and strong capital allocation policies.
The combination of these 3 ETFs give you exposure to US, Canada, and global markets, dividends and capital gain objectives, professionally managed, currency diversification, and more.
Review these on your own.
