Ready for liftoff?

As ETFs gain increasing attention, investors see more options and benefits

It’s now more than a quarter century since the first exchange-traded fund launched in Canada, an event many market watchers assumed signalled the beginning of an inevitable, rapid disruption of the fund industry. Surely, the thinking went, making low-cost, tax-efficient investment diversification available to Canadians everywhere on the wealth spectrum would change everything.

The reality has turned out to be more complex. On one hand, more than 400 ETFs traded on the Toronto Stock Exchange in 2016, and in percentage terms, asset growth in the sector continues to outpace traditional mutual funds. On the other, Canadians own about $123-billion in ETFs – compared to $1.3-trillion in mutual funds.

The opportunity for ETF sector growth ahead is not lost on the financial industry, notes Yves Rebetez, managing director and editor of ETF Insight. “There is growing recognition that there is still a long runway, and it’s triggering the arrival of a slew of new market participants.”

Yet – because of their much lower fees – wider adoption of ETFs means lower profit margins across an industry in which, as the adage goes, “investments are sold, not bought.” Most Canadian advisers still receive a significant part of their income in the form of commissions on traditional mutual funds. For the banks, fund companies and insurers that issue funds, profit margins on managed products are significantly more generous than those on ETFs, and even more so as competition drives ETF fees even lower. “In terms of potential return expectations for financial firms, it is a threat to have ETFs become too prevalent,” says Mr. Rebetez.

Warren Collier, head of iShares at BlackRock Canada, has a more glass-half-full view. “We continue to see rapid growth in the ETF industry overall, and in core products in particular. If you look at 2016 over 2015, flows into traditional mutual funds were down 36 per cent and were essentially flat in ETFs; Investor Economics shows ETFs as a share of total fund flows going from 17 per cent in 2014 to 27 per cent in 2015 and 36 per cent last year.”

In addition to the continued growth in the use of core ETFs for basic portfolio construction, Mr. Collier points to three other positive trends: growth in the use of fixed-income ETFs, growth in “smart beta” (alternative index weightings) ETFs and the increasing use of ETFs as strategic portfolio holdings alongside stocks, bonds and funds.

In the fixed-income space, retail and institutional investors traditionally accessed bonds through banks, but regulatory changes have driven up the costs of holding bonds on bank balance sheets. As a result, he says, fixed income ETFs have increasingly become the way investors of all kinds access bonds. “That growth has been dramatic globally, it’s been incredibly strong in Canada, and we believe we’re just getting started.”

Robo-advisers, firms that use technology to provide low-cost baseline advice to clients and ETFs to fulfill portfolio allocations, are also opening up new possibilities for sector growth.

Wealthsimple, a robo-advisory firm now backed by industry giant Power Financial, launched in Canada in September 2014. After attracting 20,000 Canadian users and $750-million in assets, it rolled out services in the U.S. in January. A viral Super Bowl ad and a finely tuned focus on younger investors have made it something of a social media phenomenon, but its value proposition is simple. “We’re all about making investing easy,” says 29-year-old founder and CEO Mike Katchen.  “We make full-service investment accessible to anyone, with any account size. We give every Canadian access to a fully diversified portfolio and we use ETFs to do that, because they’re a great tool for diversification, with low fees and tax efficiency.”

That accessibility is critical, says Mr. Katchen, because research shows that investors with managed portfolios tend to do better. “It’s hard to manage your own money. You can get excited at the wrong time; you panic at the wrong time. If you don’t have anyone to talk to and help you stick to a plan, it’s easy to make mistakes that can be very costly over time.”

Mr. Rebetez points out that, with 11 robo-advisory firms online at the end of 2016, these services have yet to translate into measurable new growth in assets in the ETF sector. But it is still early days – as Mr. Katchen reports, even the millennial-focused Wealthsimple’s client base is becoming more diverse as 20- and 30-somethings recommend it to their parents and grandparents.

Our oldest client is now 103,” he says.  

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