ETF Investing Basics

Using exchange traded funds as an investing tool

ETF Tools and Resources

Use this section to easily identify the right products.

ETF Dashboard

Your leading source for ETF industry trends and insights.

ETF Investing Strategies

Strategies to help you efficiently implement your investment views and maximize portfolio performance.

Efficient Exposure

Investors get access to both core ETFs that track broad indices such as the S&P 500 and more focused ETFs that track market sectors and industries.

Liquidity

ETFs provide intraday liquidity through buying and selling during the trading hours of the stock exchange.

Diversification

ETFs offer potentially lower risk than individual securities.

Portfolio Transparency

Investors have access to the price of an ETF and the portfolio composition at any time during regular market trading hours.

Cost Effective

Generally management fees for ETFs are lower than many other investment solutions. This means more of your money is working for you over the long term.

Tax Efficient

ETFs provide the potential for relatively lower capital gains tax liabilities than other investment products.

How they work?

ETFs can be bought and sold at any point throughout the trading day through your advisor or trading platform.

Market Tracking

The purpose of an indexed ETF is to track as closely as possible the return of a specific market benchmark or index. Deviation from the benchmark return, known as a tracking error, can occur for several reasons:

  • Trading Costs. However, since the underwriters deliver, or take possession of, the underlying securities during subscriptions and redemptions, ETFs lessen the need for the Fund Manager to trade securities on the exchange. Therefore, trading and commission costs are kept to a minimum.
  • Cash drag is the result of an un-invested portion of a portfolio’s net assets. ETFs will seek to minimize cash drag by reinvesting the proceeds or providing income distributions to investors.

Understanding Liquidity and Building Equity

The liquidity of an individual security is directly related to the traded volume of that security, the same correlation however does not apply to ETFs.

Instead, the liquidity of an ETF is best measured by the underlying securities which it holds. If the individual securities that compose the ETF have a high traded volume, and are therefore very liquid, then the ETF that holds them will have the same degree of liquidity. Similarly, if the underlying securities of the ETF have a low traded volume, or are illiquid, the ETF will have a low degree of liquidity as well. BMO ETFs have been constructed to have liquid portfolios by establishing traded volume requirements for each security held within the portfolios.

How does the ETF liquidity mechanism work?

First level of liquidity – On the exchange

The interaction between buyers and sellers creates the first level of liquidity for an ETF. This natural liquidity is established when a sell order from an existing unit holder is matched with a buy order from a purchaser on the exchange. Popular and established ETFs with high transaction volumes can develop even greater liquidity than their underlying holdings.

Second level of liquidity – Market maker activity

Market makers are responsible for posting bid and ask offers on the exchange. This enhances liquidity and allows a buyer or seller to transact with minimal trading costs. Market Makers continually post units at a price which reflects the spread of the underlying portfolio.

Third level of liquidity – Unit creation based on underlying securities

Market makers can offset an increase in demand by creating more units. On the other hand, when the demand for the units decreases, the market maker redeems units to tighten supply. When a large buy order occurs, the market maker will buy the basket of securities and initiate a creation order with the ETF provider.
When evaluating ETFs, the underlying liquidity is what matters. The true liquidity of an ETF is best measured by the liquidity of its underlying securities and allows for significant trade orders without having an impact on the price of the ETF itself.

ETF FAQs

Included below are the answers to most of the commonly asked questions on BMO ETFs. If you have an additional question or comment, please contact us.

Individual investors and financial advisors can contact our client services department at 1-800-361-1392 or [email protected].

Financial advisors can also contact their BMO Mutual Funds wholesaler.

ETFs

ETFs are open-ended funds that are listed and traded on a stock exchange, and can be bought or sold directly during trading hours, much like a stock. They typically represent a basket of securities which may consist of stocks, bonds, or other assets such as commodities. ETFs offer many benefits to investors, including diversification, liquidity, low fees, flexibility, transparency and tax efficiency.

  • Efficient access to core investments and focused market segments.
  • Access to institutional strategies by retail clients.
  • Provide intraday liquidity through buying and selling during the trading hours of the stock exchange.
  • Flexibility to buy on margin or sell short.
  • Diversification offers potentially lower risk than individual securities.
  • Ability to have exposure to a portfolio of stocks or bonds.
  • Portfolio transparency on a daily basis.
  • Cost-efficient due to relatively low management fees.
  • Tax efficient, with potential for relatively low capital gains distributions.

Trading ETFs

Shares of BMO ETFs can be bought and sold during normal trading hours through registered brokers and dealers in the province or territory where you reside. ETFs are not purchased directly from the ETF provider. To trade BMO ETFs, you can use any online, discount or full-service brokerage account. Your broker will charge their usual commissions or fees.

The trading price of an ETF is approximately equal to the value of the underlying holdings in the portfolio and any other asset or liabilities, such as cash and dividends receivable. The price of the ETF will move up and down during the trading day with supply and demand, but will generally reflect the price movements in the underlying holdings. Unlike a traditional mutual fund where a client receives the end of day net asset value (NAV), an ETF client trades on the intra-day price on the exchange.

In general, it may be advisable to consider using limit orders when trading any security, including ETFs, especially with large amounts. This allows investors to control the price, at which they are willing to buy or sell, something which can be very important in volatile markets.

The bid and ask for an ETF are similar to a stock, where the bid reflects what investors are willing to pay to buy units, and the ask reflects what investors are willing to sell units for. Unlike a stock, ETFs are open ended, meaning that supply and demand is not limited, so that a large order can result in the creation or redemption of ETF units. The bid and ask will reflect the average bid and ask of the underlying portfolio, and in addition, natural liquidity between buyers and sellers of the ETF may narrow the bid-ask spread.

BMO ETFs are designed to serve the needs of all types of investors, whether they are institutional or self-directed investors, or deal with a financial advisor.

Yes, all BMO ETFs are RRSP, RRIF, RDSP, and TFSA eligible. In general, BMO ETFs that qualifies as a mutual fund trust and that are listed on an established market index are eligible for registered plans, you should consult with your own broker or tax advisor regarding your personal circumstances.

BMO ETFs are offered through a prospectus filed in accordance with Canadian securities laws and regulations. Neither the securities of the ETFs nor the ETFs are registered with the United States Securities and Exchange Commission, or in any other jurisdiction. Generally persons that are non-residents may invest through a broker by placing purchase orders on the Toronto Stock Exchange.

BMO ETFs

ETFs and mutual funds are both designed to provide easy access to a variety of investment options and both can be used to build an optimal portfolio that is right for each client. By expanding its range of investment products to include ETFs, BMO is giving investors additional choices so that they can make appropriate investment decisions tailored to meet their specific needs, whether it is on their own or with the assistance of a financial advisor.

BMO ETFs look at each portfolio separately and selects the most appropriate weighting methodology for that ETF. Market capitalization weighting for broad markets and diversified exposures provide the expected return of well followed indexes. Smart beta or strategic weighting increases an ETF’s exposure to the desired factor, such as low volatility, higher income, or quality. Equal weighting removes concentration risks where sectors and industries can be skewed by high concentrations in one or two larger companies.

In general, it may be advisable to consider using limit orders when trading any security, including ETFs, especially with large amounts. This allows investors to control the price, at which they are willing to buy or sell, something which can be very important in volatile markets.

Tracking error is the performance difference between an ETF and its benchmark index.

Whenever holdings are traded in a currency other than the Canadian Dollar, currency movements are a key factor in total returns. BMO ETFs may have exposure to the local currencies where the underlying holdings are traded, or they may be currency hedged to remove most of the currency returns from the underlying holdings. BMO ETFs that are currency hedged generally have “Hedged to CAD” included in the ETF name.

The BMO Covered Call ETFs provide call premium income in addition to the dividend income on the portfolio. This strategy involves selling call options against the underlying holdings, where a premium is received in exchange for the excess upside return of the holding. This strategy is most effective when the underlying portfolio is expected to be range bound (limited expectations of large price movements). The covered call strategy is considered to be defensive as the additional income partially offsets potential portfolio decreases while removing the participation in large market upswings.

Our goal is to deliver a comprehensive line-up of BMO ETFs that meet the current and future needs of ETF investors. To do this we will be evaluating our ETF line-up on a regular basis and making additions as we identify opportunities.

Fixed Income ETFs

Fixed income ETFs incorporate all of the benefits of a typical ETF – diversification, liquidity and cost effectiveness, and are effective core holdings in a portfolio. A fixed income ETF may also be appropriate for those investors who wish to take an active role in positioning their fixed income portfolios to reflect their own economic expectations. With BMO ETFs, investors can use long or short positions, as well as target specific fixed income durations or credit risks.

The interest paid on a bond is known as the coupon rate. The weighted average includes all of the underlying holdings in the portfolio.

Unlike equities that have no maturity, bonds have a fixed maturity; the return to that date can be measured using current prices. Yield to Maturity (YTM) is the discount rate that equates the present value of a bond’s cash flows with its market price (including accrued interest). The weighted average includes all of the underlying holdings in the portfolio.

Duration measures the approximate sensitivity of a bond’s price to a change in interest rates, where bond prices are inversely related to interest rates. A duration of 3, for example, means that the price of the bond would increase by approximately 3% if the interest rate decreased by 1%. The weighted average includes all of the underlying holdings in the portfolio.

Tax Considerations

Generally, the tax considerations of investing in a BMO ETF include the treatment of distributions paid by the BMO ETF and the treatment of the gain or loss realized on selling the investment in the BMO ETF.

BMO ETF Taxation

A Canadian resident investor who sells ETF units that were held by the investor as capital property will generally be considered to realize a capital gain (or capital loss) in the amount by which the sale proceeds, net of reasonable expenses of the sale, exceeds (or is less than) the investor’s adjusted cost base (“ACB”) of the units.

BMO ETFs pay distributions as income or capital gains. The term “dividends” is usually used to describe distributions paid on shares of a corporation; however, some ETFs, especially in the US, use the terms dividends and distributions interchangeably to refer to distributions of income of all types, including dividends, interest and capital gains. We specifically use the term “distributions” as the appropriate term when discussing BMO ETFs.

While your primary focus as an investor should be on the yield from your investment as well as the capital appreciation, the tax treatment of distributions on the investment is also important. From a tax perspective, distributions from ETFs are composed of the following types of income:

Dividends
The individual stocks or shares held by an ETF pay dividends that are received by the ETF. Distributions by an ETF to investors out of the ETF’s dividend income are generally treated as ordinary income to the investors. However, where the ETF pays a distribution out of dividends received by the ETF from Canadian companies, an investor can treat that distribution as if it were a dividend from a Canadian company. For investors who are Canadian resident individuals, this means that such a distribution qualifies for the lower effective tax rate applicable to dividends from Canadian companies.

Interest and Other Income
Fixed income ETFs receive interest on their investments in bonds and other debt obligations. Distributions by an ETF to investors out of the ETF’s interest and other income are generally treated as ordinary income to the investors.

Capital Gains
An ETF may also realize capital gains on the sale of investments in the ETF’s portfolio. If the ETF pays a distribution to investors out of its net realized capital gains, an investor can usually treat this distribution as if it were a capital gain realized by the investor. As is the case for realized capital gains, only one-half of such a capital gains distribution has to be included in the investors’ income.

Foreign Income and Foreign Tax Paid
An ETF may earn dividends or interest on foreign investments and therefore be required to pay foreign withholding tax. When the ETF pays distributions out of this foreign income, an investor that pays Canadian tax may be able to claim a foreign tax credit for some of the foreign tax paid by the ETF, depending on the investor’s particular situation.

Return of Capital
In some cases, an ETF may distribute an amount to investors as a return of capital that is generally not taxable to investors. However, such a distribution will decrease the ACB of the investor’s units. When the investor sells the ETF units, the lower ACB will increase the capital gain (or decrease the capital loss) that would otherwise be realized on the sale.

BMO tax parameters outline the tax composition of distributions, broken down per unit. Please see here for more information on tax parameters for 2016 taxation year.

BMO Asset Management Inc. does not provide information about the tax implications for non-resident investors in BMO ETFs. Non-resident investors should contact their brokers, financial advisors, lawyers, and tax advisors to obtain more information on securities regulation, as well as currency and taxation issues in regards to investing in BMO ETFs.

BMO ETFs pay distributions out of their income in cash on either a monthly, quarterly, or annual basis. Generally, the greater the income in the fund, the higher the distribution frequency. Download the BMO ETFs Distribution Calendar