Many financial gurus say the key to successful investing is diversification. It wasn’t all that long ago that getting broad market diversification in a portfolio was costly and difficult, but exchange-traded funds have made do-it-yourself investing more practical — and there are some big changes happening now in the Canadian ETF market as a result.

In the past, an investor would either have had to deal with a stock broker – an endangered species these days – to buy individual shares in companies. Or maybe pay to have a professional money manager manage their investments in a mutual fund.

But in 1990, a tiny product made its debut on the TSX and it ushered in a sea change in the way Canadians invested for retirement. That was when Toronto Index Participation Shares made their debut.

Modeled on instruments that had just appeared on the NYSE months earlier, TIPS were designed to track the Toronto 35 Index of the 35 largest companies on the TSX at the time.

Although the acronym ETF (which stands of Exchange Traded Fund) wouldn’t appear until a while later, the now ubiquitous investment vehicles were very much born out of TIPS.

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In recent years, the amount of money people have been socking away in ETFs has skyrocketed. From those humble origins, ETFs have grown into an asset class that holds almost $1.5 trillion US worth of investment dollars. And of the 2,500 ETFs in existence, a disproportionate number of them trade on the Toronto Stock Exchange.

On paper, their appeal is obvious. They provide access to a broad basket of securities. They’re also easy for investors to get in and out of, hopefully at a rock bottom price well below what would otherwise be possible in actively managed mutual funds or individual stocks.

ETFs appeal to passive investors, financial planner Judith Cane says, because they allow people to sit back and forget about an investment. "Unless you’re going to do this full-time, you can’t outsmart the market."

There’s certainly been a flood of money into the sector based on that line of thinking of late. Assets in Canadian ETFs rose by 13 per cent to $43 billion in November.

Major players

ETFs attracted almost 20 per cent more money in 2011 than they did in 2010, a trend that shows no sign of slowing despite wobbly global stock markets

That eye-popping growth data came from a recent report by NY-based BlackRock. As world’s largest money manager, BlackRock knows what it's talking about. The company manages the popular line of iShares funds. From humble beginnings, iShares have grown to hold $28 billion in assets spread across almost 70 funds – good enough for a 67.5 per cent share of Canada’s ETF market.

In January 2011, BlackRock moved to buy its next-largest Canadian rival, Claymore Investments. Headed by president and CEO Som Seif, Claymore is a subsidiary of Chicago-based Guggenheim Funds Services Group but under a deal unveiled on January 11, the company’s funds will head over to BlackRock.

'I’m a little concerned about some of the new entrants.'—David Chilton, author of The Wealthy Barber

While the company tries to differentiate its offerings in a number of ways, many of the company’s funds use what’s known as a "fundamental indexing" strategy. It’s designed to guard against one company becoming so big that it tends to dominate holdings, as Nortel did in the 2000s when it grew to make up more than a third of the TSX’s total value.

Another popular choice is Horizons Exchange Traded Funds Inc. The firm, founded as a part of Jovian Capital Corporation but recently sold to Mirae Asset Global Investments Co., offers a suite of passive and actively managed funds. Horizons has more than $3.3 billion under management.

The company has 75 ETFs on offer, but the two that tend to draw the most attention are the BetaPro Bull and Bear ETFs. Each uses leverage to accentuate the movements of the broader market. Every 1 per cent gain or rise in the TSX causes the corresponding BetaPro Bull or Bear ETF to increase by two per cent.

Advisers like them for short-term hedging strategies, but their fairly complicated structure has made them hard to understand – even dangerous – for retail investors, so they’re largely a tool for investment professionals.

Horizons also sells a suite of funds called AlphaPro that offer active management, aimed at investors who aren’t happy with passively trying to track a popular benchmark.

Big banks

Even the big banks are getting in on the ETF action.

Royal Bank of Canada and Bank of Montreal have each come to market with broad equity ETFs of late, hoping to use their extensive retail networks and brand recognition to cater to investors looking for low-cost indexing.

Although neither bank’s ETF business has made a significant dent in market share as of yet, when Canada’s big banks get involved in a sector it’s only a matter of time before changes happen.

With that new financial heft, it’s no surprise that ETFs are starting to do some new things. They’ve been criticized for straying from their low-cost origins and getting into more and more niche products, for example.

But ultimately, the savvy investor has more choice than ever before, and that has to be a good thing, according to investing experts.

"I’m a little concerned about some of the new entrants," says David Chilton, author of the popular investing book The Wealthy Barber and its new sequel. "But the initial entrants that provide broad baskets of stocks at a low cost? It’s tough to argue with that."