A Guide to Investing in Canadian ETFs

As the Canadian Investment Regulatory Organization (CIRO) settles in following the merger of IIROC and MFDA, the landscape for ETFs continues to expand. The growing investor preference for ETFs, driven by their transparency and cost-efficiency, underscores the importance for advisors to understand this evolving market and effectively integrate these vehicles into their investment strategies. This guide breaks down key misconceptions, emerging trends, and the tax nuances that can impact investor outcomes. 

Download the full Canadian ETF Primer report for key insights and investor benefits. 

ETFs offer key structural advantages over traditional mutual funds. Investors can buy or sell ETFs throughout the trading day at market prices, unlike mutual funds, which only trade at end-of-day net asset value (NAV). This intraday liquidity adds flexibility and introduces small trading costs like bid-ask spreads or slight NAV deviations. 

Unlike their US counterparts, Canadian ETFs and mutual funds do not differ significantly in tax treatment due to regulatory parity. The significant tax benefits stem from the passive nature of many ETF investment strategies, which tend to trigger fewer taxable events. 

ETFs typically feature lower management fees than mutual funds. The average management expense ratio (MER) for ETFs is 0.66%, compared to 1.33% for mutual funds. This cost advantage can compound significantly over time. 

Both ETFs and mutual funds can pursue active or passive investment objectives, although ETFs have historically been associated with index-tracking and passive asset management. Vanguard’s 2018 entry into Canada’s allocation ETF market sparked a wave of fee cuts and low-cost launches from competitors. This “Vanguard effect” has driven down average fees across asset classes.  

ETFs handle investor trades differently than mutual funds. Mutual fund transactions go through the fund itself, forcing managers to buy or sell holdings. In contrast, most ETF trades occur between investors on an exchange and don’t affect the fund’s underlying assets unless they trigger large-scale creations or redemptions handled only by designated brokers. 

ETFs also tend to trade less frequently, especially passive ones, which can lead to fewer capital gains distributions. And while intraday trading may not matter to every investor, ETFs generally avoid sales loads and holding-period fees, making them more cost-efficient, even for annual rebalancing or use in model portfolios. 

ETFs currently face limitations when it comes to distribution. Many Canadian investors rely on financial advisors who operate on Mutual Fund Dealers Association (MFDA) platforms that only allow access to mutual funds. This has historically restricted ETF availability in advisor-led channels.  

The recent merger of the MFDA with the Investment Industry Regulatory Organization of Canada (IIROC) marks a regulatory turning point. The combined framework is expected to expand access to ETFs and other investment vehicles while preserving the advisor-client relationship that many investors value. 

ETFs get their name from being traded on exchanges like stocks. Unlike mutual funds, which trade at NAV, ETFs trade at market prices that can deviate from their NAV. When an ETF trades above its NAV, it’s at a premium; below NAV, it’s at a discount; both scenarios can add hidden costs for investors. 

Designated brokers (DBs) help manage these price gaps by creating or redeeming ETF shares at NAV. This process helps align an ETF’s market price with its underlying value and narrows the bid/ask spread. 

Larger, more liquid ETFs typically trade close to NAV, minimizing cost. In contrast, smaller ETFs can experience wider spreads and greater price deviations.  

Direct Advisory Suite includes data on tracking errors and differences to help advisors evaluate whether an ETF delivers on its stated investment strategy.  

To prevent excess costs, here are some best practices to follow: 

• Use limit orders: Avoid unfavorable prices by setting a maximum buy or minimum sell price. It is especially important for smaller, less-liquid ETFs. 

• Avoid trading near the open or close: Bid-ask spreads tend to be wider during the first and last 15 minutes of the trading day. Midday trading often offers better pricing. 

• Trade when underlying markets are open: Align trades with the trading hours of the ETF’s underlying holdings to improve price accuracy and execution. 

• Call for large trades: For orders over 20% of average daily volume or 1% of assets, consider calling a broker or ETF provider to minimize execution costs. 

Unlike mutual funds, ETFs cannot close to new investors. When ETFs grow too large relative to the liquidity of their underlying assets, they can run into capacity constraints. This may force the ETF to alter its investment strategy or, in rare cases, shut down altogether. Although most broad-market ETFs avoid these issues, capacity concerns can affect specialized or narrowly focused funds. 

Survival is not guaranteed. ETFs that are too big for their underlying market might reach their capacity and fail, but ETFs that are too small have their own existential threats. Of the more than 2,200 ETFs launched in Canada, nearly 600 have shut down.   

Most closures involved small ETFs, typically those with less than CAD 100 million in assets, and many lasted fewer than four years. Providers often shutter ETFs that fail to attract investor interest, and those with limited scale may struggle to cover operational costs. Advisors should assess both the asset size and age of an ETF to gauge its staying power. 

ETFs are often viewed as low-cost alternatives to mutual funds, and for the most part, that holds true. However, not all ETFs are inexpensive. Alternative ETFs, such as those investing in crypto or using leverage, charge an average fee of 1.77%, and those fees have been rising. 

Investors should consider the fee and how it compares to similar funds. A high-cost ETF may only be worth the premium if it consistently delivers net-of-fee outperformance. Morningstar research shows that lower-cost ETFs tend to outperform more expensive peers over time, especially within passive strategies. 

Canadian investors significantly overweight domestic ETFs, especially those tracking Canadian equities. This home bias can lead to a lack of global diversification, which limits long-term growth potential and increases exposure to local economic risks.  

Advisors can help investors dig into the underlying holdings of their ETFs to understand where their money is going. Many global ETFs still have significant US exposure, and relying on fund names alone can be misleading. A more balanced portfolio often starts by looking beyond Canada’s borders. 

How and where you hold ETFs matters, especially for international investments. For example, a Registered Retirement Savings Plan (RRSP) is the most tax-efficient vehicle for US equity ETFs. Thanks to the Canada-US tax treaty, dividends from US stocks are exempt from withholding taxes when held in an RRSP. 

But that benefit doesn’t extend to Tax-Free Savings Accounts (TFSAs) or Registered Education Savings Plans (RESPs). In those accounts, foreign withholding taxes apply and can’t be recovered. It’s also important to watch out for Canadian ETFs that hold US-listed ETFs containing international securities. These “fund-of-fund” structures can result in double taxation, once by the US and again by Canada. 

While ETFs already offer access to a wide range of asset classes and strategies, investors seeking alternatives should proceed thoughtfully. Tools like the Morningstar Medalist Rating for semiliquid funds can help compare nontraditional investments such as private credit or real estate against each other and assess their fees, risk profiles, and potential rewards. 

The Canadian ETF market has transformed rapidly. As of 2024, assets totaled $570 billion, nearly triple what they were five years ago. Here’s what’s driving the momentum: 

Crypto, covered call, and leveraged ETFs are gaining traction despite their higher complexity and fees. These products appeal to investors seeking yield or directional bets, but they come with unique risks and should be treated with care. 

Balance ETFs which offer a mix of stocks and bonds in a single vehicle, still represent a small slice of the market, just 9%, but demand is rising. As traditional allocation mutual funds lose assets, more investors turn to ETFs for diversified, low-cost exposure. 

High-Interest Savings Account (HISA) ETFs surged in popularity thanks to attractive yields. But that trend slowed in 2024 after new OSFI liquidity rules reduced their appeal. Advisors may want to watch for potential yield compression in this segment moving forward. 

The continued rise of ETFs is reshaping investor expectations and the broader fund landscape in Canada. Here’s what that means for the future: 

• More pressure on fees: As ETFs grow in popularity, the cost gap between ETFs and mutual funds is pushing down fees industrywide. Investors are demanding more value for their money. 

• Broader product variety: The surge in ETF launches has created a menu of options, from simple index trackers to sophisticated thematic and alternative strategies. This gives investors more tools to tailor portfolios to their goals. 

• Higher expectations for transparency: As ETF use grows, so does scrutiny. Investors want to understand what’s under the hood. Transparent holdings, consistent NAV tracking, and low tracking error are increasingly non-negotiable.