Cluttered market for ETFs makes it hard to find right fit
There are 648 ETFs listed in Canada, with more coming all the time
Do you own any exchange-traded funds (ETFs)? If not, you are one of a dwindling minority of Canadian investors. We’re entrusting our money to these relatively new products at a record rate, enticing more companies to compete for a share of this red-hot market.
According to a report published by National Bank earlier this month, we invested $26 billion in ETFs in 2017, a record high. That brings the total ETF assets under management to $147 billion. That’s still way below the amount invested in traditional mutual funds, but the ETF market clearly has momentum on its side. It’s also becoming cluttered. There were 169 new products launched in 2017. That’s almost one every second day. There are now 648 ETFs listed in this country, with more coming all the time.
Not all of them will survive in this cutthroat environment; last year saw the Evolve Funds buy Sphere’s small ETFs, while U.S. giant Wisdom Tree, which is trying to make inroads into Canada, bought the Questrade family.
ETFs originated as a cheap and simple way to invest in the broad stock market. For a fraction of the price of a traditional mutual fund, you could own a piece of the S&P/TSX Composite Index, the S&P 500, or the Dow.
Those inexpensive funds are still available and represent good value for money, which is why most of the new cash inflows still go there.
But some investors have become intrigued by more complex and potentially higher risk/return options.
One example is leveraged ETFs, where price movements in the underlying commodities can trigger huge gains or losses for investors. This is the stock market equivalent of a trip to Las Vegas — if you bet right, you win a bundle; if you’re wrong, you may lose the house.
One example: the Horizons BetaPro Natural Gas -2x Daily Bear ETF, which bets on a drop in gas prices. It gained 67 per cent in 2017, while its companion fund, which pays off if natural gas prices go up, lost a similar amount. This is not investing; it’s a crapshoot.
While most ETFs are passively managed (they just track a benchmark index), National Bank reports a growing interest in active funds — those where a manager makes the decisions on how the money is to be invested. The bank found that actively managed fixed-income ETFs captured 41per cent of the new cash flows into that sector. This is not surprising as rising interest rates make investing in index-driven bond and preferred share ETFs increasingly problematic.
Options-based ETFs are also growing in popularity. These employ various strategies such as covered call writing to increase cash flow for income-oriented investors.
BMO is the leader here, with seven covered call funds and three based on put options. One of my favourites is the BMO Covered Call Canadian Bank ETF, which had a five-year average annual compound rate of return of 11.7 per cent as of the end of December.
We are also seeing some interest in ETFs that focus on niche sectors of the market. The little-known Evolve Funds are the main innovators here, with the larger Horizons organization a close second. Here are some of more offbeat newcomers: Evolve North American Gender Diversity Index ETF: As the name implies, this fund invests in U.S. and Canadian companies that have demonstrated a commitment to gender equity in the workplace. Most of the companies are American and include names such as Marathon Oil, Qualcomm, Tyson Foods, Mosaic, Marriott and Amazon. The fund was only launched in September, so it is too early to get a reading as to whether companies that have espoused gender equity will outperform the broad index. Encouragingly, however, the hedged version of this ETF gained 6.3 per cent in the three months to Dec. 31. That didn’t impress investors however; the fund has only attracted $2.2 million in assets. Evolve Automobile Innovation Index ETF: The focus here is on companies that are leading the coming auto revolution by developing electric drivetrains, self-driving cars, batteries and support systems. Perhaps surprisingly, the top holdings do not include Apple or Alphabet. Instead, you are buying positions in 31 international firms like AMS (an Austrian company that makes sensors), Volkswagen, and Ambarella Inc., a U.S. developer of image processing and computer vision solutions. Again, this fund has only been active since late September, but posted a three-month gain of 3.1 per cent to the end of December (hedged version). Horizons Robotics and Automation Index ETF: This fund has only been around about six weeks, but it has already attracted about $23 million in assets. It invests in an index that tracks robotics or automation-related companies. Most of the top holdings will be unfamiliar to investors; they include names such as Irobot Corp., IPG Photonics, Fanuc Corp. and Oceaneering International. The fund is really a Canadian-hedged version of a U.S. ETF with the same ticker symbol that trades on Nasdaq. It was launched in October 2013 and posted a big gain of 44.2 per cent in 2017. The U.S. version has been a huge hit with investors, with more than $2.2 billion in assets.
This is just the tip of the iceberg. There will be a lot more ETFs coming this year and more companies will enter the market. The trick will be to sort out the good ones.