As ETFs grow in popularity and diversify in style and structure, old myths persist and new misconceptions can arise. One of the ongoing discussions about ETFs is their risk profile relative to traditional mutual funds. While different in structure, ETFs are not fundamentally riskier than mutual funds. Here’s why.
ETFs vs. mutual funds
ETFs and mutual funds are both baskets of securities, sold in shares to investors. They offer market diversification in an easy-to-access investment vehicle. The basket may contain stocks or fixed-income securities from any region or sector, depending on the product’s mandate. The two vehicles differ in how they are structured, bought, sold and taxed. But is one risker than the other?
According to Mackenzie Investments, a Canadian provider of both mutual funds and ETFs, “There is no notable research that demonstrates that ETFs are riskier than mutual funds. The risk or volatility associated with any fund structure, whether ETF or mutual fund, is influenced by various factors.” Ultimately, for both mutual funds and ETFs, risk comes down to the underlying securities.
Whether structured as a mutual fund or an ETF, there are risks inherent to participating in markets by buying a basket of securities.
Inherent risks
The potential risks associated with mutual funds and ETFs that invest in market-based securities include:
- Currency risk
- Inflation risk
- Interest-rate risk
- Liquidity risk
- Market risk
- Country risk
- Credit risk
Similar to mutual funds, ETFs are susceptible to the standard market risks listed above. But the mistaken belief that ETFs carry more risk than their mutual fund counterparts is false and not based on any existing research or data.
The human element
Actively managed funds are those managed by a professional portfolio manager. These funds have a mandate that they must adhere to, but within that mandate, the underlying securities are selected, bought and sold by the portfolio management team. The portfolio manager’s style, approach and strategy create risk related to human decision-making.
While index-based (passively managed) mutual funds have existed on the market for many years, traditional mutual funds tend to be actively managed. The vast majority of ETFs are index-based, but in recent years, there has been a sharp increase in actively managed ETFs hitting Canadian and global markets.
Focus on the ingredients
When dining out in a new restaurant, if you want to know how spicy a dish is, you wouldn’t ask if it’s served in a bowl or on a plate — you’d ask about the ingredients.
The same applies when considering the risk profile of ETFs and mutual funds. To determine how risky an investment is, it’s the underlying holdings that are important, not the structure. As TD Asset Management, which offers both mutual funds and ETFs, states, “There is nothing inherently different about an ETF investment that would expose investors to increased risk when compared to a mutual fund.”
Whatever the investment, advisors and investors are best served if each decision is carefully considered based on the personal goals and circumstances of the investor to ensure that the product – whether mutual fund or ETF – meets the risk profile of the portfolio.