MAR­KET SHAKEUP

Com­pe­ti­tion is heat­ing up as firms scram­ble to meet ris­ing de­mand for ETFs

Investment Executive - - CONTENTS - BY JADE HEMEON

Many more ETF providers, prod­ucts and part­ner­ships are trans­form­ing the in­dus­try.

T he ETF in­dus­try in Canada is grow­ing at a scorch­ing pace. Not only is the vol­ume of as­sets flow­ing to ETFs con­tin­u­ing to soar, but the range of fund man­dates is ex­pand­ing rapidly, as are the num­bers and types of firms that pro­vide ETFs.

That growth is cre­at­ing a host of op­por­tu­ni­ties — and chal­lenges — for fi­nan­cial ad­vi­sors and their clients, who are still get­ting to know this rel­a­tively new in­vest­ing ve­hi­cle. There’s no ques­tion, how­ever, that ETFs have cap­tured the in­vest­ment in­dus­try’s full at­ten­tion and that strong growth is likely to con­tinue.

Says Michael Cooke, se­nior vice pres­i­dent and head of ETFs with Macken­zie Fi­nan­cial Corp.: “Ev­ery as­set man­ager has an ETF strategy. They may be in­tro­duc­ing their own ETFs; they may be ac­quir­ing an ETF provider; or they may have made a con­scious de­ci­sion to stay away. But ETFs are too big to ig­nore.”

Num­bers tell the story. In 2017, there were mas­sive net in­flows of $25.8 bil­lion into Cana­dian-listed ETFs — smash­ing all pre­vi­ous records and bet­ter­ing the pre­vi­ous sales record set in 2016 by more than 50%, ac­cord­ing to fig­ures pro­vided by Na­tional Bank Fi­nan­cial Inc. (NBF) of Toronto. Pro­pelled in part by buoy­ant fi­nan­cial mar­kets through­out most of last year, as­sets un­der man­age­ment (AUM) in Cana­dian ETFs of $147.1 bil­lion, as of Dec. 31, 2017, rose by a ro­bust 30% yearover-year. Al­though the $1.5 tril­lion in Cana­dian mu­tual fund AUM dwarfs that of ETFs, the rate of growth in ETF AUM is the great­est since 2009, when mar­kets re­cov­ered strongly fol­low­ing the 2008-09 global fi­nan­cial cri­sis.

De­spite the re­turn of volatil­ity and height­ened ner­vous­ness in mar­kets ear­lier this year, the out­look for ETFs re­mains strong. Cana­dian-listed ETF AUM rose to a new high of $150.1 bil­lion as Feb. 28.

Ex­plain­ing these mas­sive in­flows is an in­ex­act sci­ence, but both providers and ad­vi­sors are key­ing on a few con­sis­tent trends. For one, the easy trade­abil­ity and trans­parency of ETFs is at­tract­ing many in­vestors who typ­i­cally buy stocks and bonds di­rectly.

In ad­di­tion, the gen­er­ally lower man­age­ment costs of ETFs in com­par­i­son to mu­tual funds ap­peal to in­vestors look­ing for bas­kets of se­cu­ri­ties to pro­vide di­ver­si­fi­ca­tion and mar­ket re­silience in their port­fo­lios. Low costs also at­tract in­creas­ing num­bers of ad­vi­sors who have switched to fee-only ad­vice and seek ways to con­tain costs for their clients.

Fur­ther­more, as the va­ri­ety of ETF op­tions pro­lif­er­ates, these new in­vest­ment pos­si­bil­i­ties are in­trigu­ing in­vestors. “It’s still a nascent in­dus- try, with new play­ers, prod­ucts and trends emerg­ing,” says Daniel Straus, an­a­lyst, ETFs and fi­nan­cial prod­ucts, with NBF, who adds that growth in the in­dus­try con­tin­ues to be “eye-pop­ping.”

Com­pe­ti­tion for new in­vestors is stiff. As providers are acutely aware, a record 169 ETFs were launched last year, push­ing the to­tal num­ber of Cana­dian-listed ETFs to 648 as of Dec. 31. To be sure, not ev­ery ETF is a suc­cess, and these num­bers in­clude 22 ETFs that were closed down dur­ing the year, ac­cord­ing to NBF. But the del­uge of new op­tions con­tin­ues in 2018, with an­other 36 ETFs added in the first two months of this year.

Even more telling, the num­ber of firms now pro­vid­ing ETFs has soared to 28 com­pared with 17 at the end of 2016 and a mere seven only five years ago. “The big­gest story in ETFs is the mas­sive growth in the num­ber of providers,” says Mark No­ble, se­nior vice pres­i­dent, sales strategy, with Toronto-based Hori­zons ETFs Man­age­ment (Canada) Inc. “There’s been a seis­mic shift in the as­set-man­age­ment in­dus­try as tra­di­tional fund com­pa­nies that may have seen ETFs as a threat now are en­ter­ing the busi­ness.”

New en­trants last year in­clude rec­og­niz­able names such as Man­ulife In­vest­ments, a di­vi­sion of Man­ulife Fi­nan­cial Corp.; Franklin Tem­ple­ton In­vest­ments Corp.; AGF In­vest­ments Inc.; and PIMCO Canada Corp. (all based in Toronto); as well as Lévis, Que.-based Des­jardins Group. Toronto-based Sun Life Global In­vest­ments (Canada) Inc. (SLGI) dove in when it pur­chased Mis­sis­sauga, Ont.-based

“The big­gest story is the mas­sive growth in the num­ber of providers”

”There are a lot of new en­trants. We could see con­sol­i­da­tion, even as the in­dus­try is grow­ing”

Ex­cel Funds Man­age­ment Inc. and its sta­ble of mu­tual funds and ETFs in late 2017. How­ever, SLGI an­nounced in March that it’s ter­mi­nat­ing Ex­cel’s ETFs as the firm re­fines its ETF strategy.

Ex­ist­ing dis­tri­bu­tion net­works can be a ma­jor ad­van­tage for this group. Macken­zie, which launched its first ETFs in late 2016, gar­nered about $1.3 bil­lion in ETF AUM by the end of 2017 and sales mo­men­tum is ac­cel­er­at­ing, says Cooke. Gi­ant wealth man­agers, such as banks, as well as in­sur­ance and mu­tual fund com­pa­nies, can cap­i­tal­ize on their long-es­tab­lished re­la­tion­ships with the ad­vi­sor net­work.

In some cases, these firms also are in­tro­duc­ing ETFs that make use of ex­ist­ing in­vest­ment-man­age­ment teams or of­fer sim­i­lar strate­gies to their suite of mu­tual funds. Says Straus: “Mu­tual fund play­ers get­ting into ETFs have an ad­van­tage over pure star­tups. [The for­mer] have a lot of tools in the box al­ready, in­clud­ing a dis­tri­bu­tion force, well­rec­og­nized fund man­agers and deep pock­ets.”

An­other at­ten­tion-grab­bing trend is the en­try of smaller names, many of­fer­ing spe­cial­ized niche prod­ucts. This group in­cludes Evolve Funds Group Inc., Red­wood As­set Man­age­ment Inc., Galileo Global Eq­uity Ad­vi­sors Inc., Equium Cap­i­tal Man­age­ment Inc. and Ar­row Funds Cap­i­tal Man­age­ment Inc. (all based in Toronto). Evolve, for ex­am­ple, of­fers gen­der di­ver­sity and cy­ber­se­cu­rity themed ETFs (see story on page 22), while Ar­row has launched an ac­tively man­aged fixed-in­come ETF that uses in­ter­est rate-hedg­ing strate­gies.

These re­cent ad­di­tions, when added to the many tra­di­tional ETF man­dates that ex­ist, are con­tribut­ing to a sig­nif­i­cant in­crease in choice for in­vestors.

“ETFs are an ef­fi­cient way to tar­get ex­po­sures in a wide va­ri­ety of as­set classes,” says Kevin Gopaul, chief in­vest­ment of­fi­cer and head of ETFs with BMO As­set Man­age­ment Inc. (BMOAM) of Toronto. “In­vestors can tar­get the spe­cific ex­po­sures they need to match their in­vest­ment ob­jec­tives and needs pre­cisely, from low volatil­ity to in­ter­na­tional ex­po­sure.”

Still, new mar­ket en­trants, big and small, have many chal­lenges, with only four firms hold­ing al­most 90% of ETF AUM in Canada. The grand­daddy re­mains Black­Rock Canada As­set Man­age­ment Ltd.’s iShares di­vi­sion, with $59.8 bil­lion in AUM as of Dec. 31. Nip­ping on its heels is BMOAM, with $46.5 bil­lion in AUM, fol­lowed by Van­guard In­vest­ments Canada Inc., with $13.7 bil­lion, and Hori­zons, with $9.1 bil­lion.

These four play­ers also ac­counted for 72.1% of net ETF in­flows in 2017. How­ever, iShares is giv­ing up mar­ket share, while BMOAM is rapidly gain­ing ground: the lat­ter’s 2017 in­flows of $10.3 bil­lion sig­nif­i­cantly out­paced the $2.9 bil­lion in AUM that iShares brought in. (See story on page 10.) Toronto-based RBC Global As­set Man­age­ment Inc.(RBCGAM) is also com­ing up fast, with net in­flows of $2.3 bil­lion in 2017, mak­ing it the fifth-largest Cana­dian ETF provider at yearend, with AUM of $4.7 bil­lion.

Not ev­ery en­trant will suc­ceed, and some mar­ket­watch­ers fore­see po­ten­tial for con­sol­i­da­tion. Up­start Evolve re­cently ac­quired Toronto-based Sphere In­vest­ment Man­age­ment Inc.’s five ETFs and con­sol­i­dated that lineup to three, while Toronto-based Wis­domTree As­set Man­age­ment Canada Inc., a di­vi­sion of New York-based ETF gi­ant Wis­domTree In­vest­ments Inc., ac­quired Questrade Wealth Man­age­ment Inc.’s ETFs in late 2017.

“There have been a lot of new en­trants, but the chal­lenge is to com­pete against the big­gest play­ers,” says Rudy Luukko, in­vest­ment funds and per­sonal fi­nance edi­tor with Morn­ingstar Canada in Toronto. “We could see more con­sol­i­da­tion, even as the in­dus­try is grow­ing.”

At the same time, the na­ture of new prod­uct of­fer­ings is shift­ing. There have been fewer in­tro­duc­tions of ETFs based on pop­u­lar, mar­ket cap­i­tal­iza­tion-weighted in­dices, al­though that group still ac­counts for most of the Cana­dian mar­ket, with more than 70% of eq­ui­ties-based ETF AUM and 70% of in­flows at yearend. In­stead, both big and small play­ers alike are in­no­vat­ing with ETFs by of­fer­ing vary­ing de­grees of ac­tive man­age­ment — from cus­tom­ized rules-based and quan­ti­ta­tive strate­gies known as “smart/strate­gic beta” all the way to the full dis­cre­tionary ac­tive­m­an­age­ment man­dates that char­ac­ter­ize many mu­tual funds.

For ex­am­ple, Evolve, Har­vest Port­fo­lios Group of Oakville, Ont., and Toronto-based Pur­pose In­vest­ments Inc. (and its sub­sidiary, Red­wood As­set Man­age­ment), are tar­get­ing spe­cial­ized strate­gies and niche ETFs, jump­ing on such hot trends as mar­i­juana, blockchain and bit­coin.

Hori­zons also launched in­no­va­tive and theme-based prod­ucts within the past year, in­clud­ing: Hori­zons Ac­tive AI Global Eq­uity ETF (TSX: MIND), which fo­cuses on ar­ti­fi­cial in­tel­li­gence tech­nol­ogy; Hori­zons Mar­i­juana Life Sciences ETF (TSX: HMMJ); and Hori­zons Ro­bot­ics and Au­toma­tion In­dex ETF (TSX: ROBO).

“We see ar­eas in the mar­ket in which ETFs, with some de­gree of ac­tive man­age­ment, can be ben­e­fi­cial,” says Raj Lala, pres­i­dent and CEO of Evolve. “Even within the [strategy] of pas­sive in­dex­ing, there still are some ar­eas around the globe that are not well cov­ered by ETFs.” Al­ter­na­tive strate­gies are an­other new cat­e­gory. Hori­zons and Pur­pose have been trail­blaz­ers in this arena, and Macken­zie of­fers Macken­zie Port­fo­lio Com­ple­tion ETF (TSX: MPCF). Other providers such as BMOAM and First As­set In­vest­ment Man­age­ment Inc. of Toronto are con­tem­plat­ing in­tro­duc­ing prod­ucts in this area as in­vestors wary of er­ratic mar­kets be­come more con­cerned about the down­side pro­tec­tion that al­ter­na­tive strate­gies can of­fer.

Robo-ad­vi­sor firms, in­clud­ing those owned by big banks, such as Bank of Mon­treal and Royal Bank of Canada, also are min­ing in­vestor ap­petite for no-frills, as­set-al­lo­ca­tion ser­vices. Robo-ad­vi­sors’ stan­dard­ized, low-cost port­fo­lios gen­er­ally of­fer ETFs only.

As well, robo-ad­vi­sors such as Toronto-based Smart Money Cap­i­tal Inc., Just­wealth Fi­nan­cial Inc. and In­vesco Canada Ltd.’s ad­vi­sorDUO are hook­ing up with fi­nan­cial ad­vi­sory firms, in­clud­ing mem­bers of the Mu­tual Fund Deal­ers As­so­ci­a­tion of Canada, to pro­vide the dealer firms with trad­ing ac­cess to ETFs. (See story on page 14.)

There are likely to be more al­liances, says Gopaul: “We will see more part­ner­ships be­tween large wealth-man­age­ment firms and the roboad­vi­sors. The banks are see­ing a need to of­fer low-touch, low-cost ad­vice. It’s in the busi­ness plan of fi­nan­cial [ser­vices] in­sti­tu­tions to be more dig­i­tally ad­vanced. Robo-ad­vi­sors use ETFs in their port­fo­lio con­struc­tion, and there is a cost ad­van­tage to that.”

Al­though ETFs have in­fil­trated vir­tu­ally ev­ery fi­nan­cial as­set class — from emerg­ing-mar­ket bonds to gold to liq­uid al­ter­na­tives — the most pop­u­lar as­set class re­mains eq­ui­ties. By yearend, eq­ui­ties-based ETFs made up $88.1 bil­lion, or roughly two-thirds of Cana­dian ETF AUM. Com­par­a­tively, fixed-in­come ac­counted for $49.1 bil­lion in AUM.

How­ever, even though fixed-in­come ETFs are newer to the mar­ket, they’re catch­ing up quickly, with net in­flows of $10.5 bil­lion last year. Given that the mar­ket cap of the global bond mar­ket is more than dou­ble that of the global stock mar­ket, the po­ten­tial for fixed-in­come growth in Canada is mas­sive. Al­ready, fixed-in­come ETF in­vestors have a smor­gas­bord of choices, in­clud­ing gov­ern­ment, cor­po­rate, high-yield, float­ing-rate loans and lad­dered bond port­fo­lios, as well as con­vert­ible bonds, global and emerg­ing-mar­kets bonds, and pre­ferred shares.

Costs are a key driver in this seg­ment. Given the low in­ter­est rate en­vi­ron­ment, in which the im­pact of prod­uct man­age­ment fees can be par­tic­u­larly cor­ro­sive to bond re­turns, the low fees ETFs of­fer are par­tic­u­larly at­trac­tive. Ac­tive strate­gies have been pop­u­lar in fixed-in­come prod­ucts, cap­tur­ing 41% of fixed-in­come in­flows last year, ac­cord­ing to Straus. Pop­u­lar prod­ucts in­clude ac­tive bond ETFs from PIMCO and First As­set, as well as ac­tive pre­ferred share-based ETFs from RBCGAM, Hori­zons and Dy­namic Funds (a di­vi­sion of 1832 In­vest­ment Man­age­ment LP of Toronto).

“In­di­vid­ual fixed-in­come se­cu­ri­ties his­tor­i­cally have traded in an opaque and illiq­uid mar­ket in Canada,” says No­ble, “How­ever, ETFs of­fer a trans­par­ent, low-cost and easily trade­able prod­uct that’s ap­peal­ing to both re­tail and large in­sti­tu­tional in­vestors.”

A re­cent BMOAM re­port pre­dicts the in­dus­try’s ex­pan­sion will con­tinue, with Cana­dian ETF AUM ap­proach­ing $400 bil­lion in the next five years. That could re­shape the in­vest­ment funds busi­ness, on many fronts.

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