Actively managed ETFs lead in Canada, lag in U.S.

Regulatory rule won’t give away ‘secret sauce’

Active managers have captured 18 per cent of Canada’s ETF market compared with just one per cent in the U.S., the result of a regulatory advantage that lets fund managers keep their strategies close to their vest.

Actively managed exchangetraded funds make up $26 billion of Canada’s $141 billion ETF market. In the U.S., active ETFs make up only US$39 billion of the US$3.25 trillion market, according to data compiled by Daniel Straus, vice-president of ETF and financial products research at National Bank Financial.

Unlike traditional ETFs that track indexes, actively managed ETFs allow for individual stock selection, potentially offering higher reward for higher risk. Their strategies run the gamut from ginning up payouts through dividend ETFs, increasing diversification with emerging markets to more exotic strains like the Horizons Active A.I. Global Equity ETF, which is run using artificial intelligence.

The reason for Canada’s embrace of active management is an obscure regulatory advantage. In Canada, which launched the world’s first ETF in 1990, actively managed ETFs are treated the same as mutual funds. This means managers only have to provide quarterly disclosure of their top 25 holdings and semi-annual disclosure of their full portfolio within 60 days of the end of the period. By contrast, all U.S. ETFs have to disclose their holdings daily — a rule that some fund managers are asking the Securities and Exchange Commission to bend.

“That has really hindered active managers in the U.S. from getting into the ETF space,” said Krista Matheson, head of ETFs and structured products at Manulife Investments, which launched its first ETFs earlier this year. “If you’re a true active manager, you don’t want to disclose your holdings on a daily basis.”

The fear that outside investors will mimic the moves of an active manager without investing in their fund — and paying the attendant fees — has also kept the U.S. market small, said Raj Lala, chief executive officer of Toronto-based Evolve Funds Group Inc., which recently launched the Evolve Active Canadian Preferred Share ETF.

“The big managers in the U.S. say there’s not a chance that I’m going to run an active ETF,” Lala said. “One, I’m going to show everybody what I’m holding and what I’m trading, so I’m giving away my secret sauce, and two, it potentially opens up the door for front-running.”

Actively managed funds are growing faster than Canada’s ETF market as a whole. Assets in active funds have grown at an annual rate of 32 per cent for the past five years compared with 20 per cent for all ETFs, according to Straus.

That’s “faster than any country in the world,” said Steve Hawkins, co-CEO of Horizons ETFs Management Canada Inc., which operates 79 ETFs and has $8.9 billion in assets under management.

The difference between the two countries has created a “regulatory arbitrage” that is encouraging fund managers from around the world to bring active strategies to Canada first, said Hawkins. Horizons offers 32 active ETFs with focuses ranging from Canadian municipal bonds to natural gas.

Canada’s regulations have allowed Horizons to create products that look like mutual funds, and “package them in a more efficient ETF wrapper,” he said. “The rest of the world still has a lot to catch up to with respect to the foresight of our regulators in allowing us to launch products like this,” he said. “We think is a very good thing for the Canadian marketplace as a whole.”