By Megan Harman | Mid-January 2012

Providers of exchange-traded funds are targeting financial advisors in an effort to increase the presence of ETFs in the broader investment fund business. In particular, ETF firms are using advisor-class funds and education programs to reach advisors, and they have formed an association to raise the profile of ETFs.

ETFs have enjoyed a surge in popularity in recent years. The sector's assets under management have grown to $43.2 billion in December 2011 from $19.4 billion in December 2008, according to Toronto-based Investor Economics Inc. But in comparison to the mutual fund business in Canada, which had $772.6 billion in AUM as of November 2011, the ETF business remains relatively small.

"It would be fair to say that ETFs haven't really reached the mass market yet," says Howard Atkinson, president and CEO of Toronto-based Horizons ETFs Inc. "These are still early days for ETFs."

Indeed, research shows that most retail investors remain uninformed about ETFs. A recent survey of more than 1,500 adults by Toronto-based BMO Investments Inc. indicates that only 18% of respondents were familiar with ETFs.

"There's still quite a bit of confusion out there," says Serge Pépin, head of investments at BMO Investments, "in terms of what ETFs are and what they are supposed to do."

Some ETF providers are responding to this lack of awareness among consumers by turning their attention squarely on advi-sors. If providers can sell advisors on the advantages of ETFs, the thinking goes, advisors will relay the message to their clients.

"We've been spending a lot of time on the education of advisors," says Barry Gordon, president and CEO of Toronto-based First Asset Capital Corp., which launched XTF Capital Corp., an ETF business, in 2011. "Lots of them haven't used ETFs in the past, and so we're trying to introduce them to some simple uses of ETFs in their portfolio-management process."

Advisor uptake of ETFs is already on the rise, ETF firms say, and they believe that better penetration of the distribution channel will unlock more growth for ETFs in Canada.

"As advisors migrate more and more to ETFs in their portfolio-management construction, we're going to see AUM in ETFs continue to grow significantly," says Gordon, who expects the ETF sector to grow to more than $100 billion in AUM in the next five years.

A lack of compensation has been a major factor in preventing advisors from embracing ETFs. Advisors who rely on commissions have generally been more inclined to sell mutual funds, from which advisor compensation comes from trailer fees.

To make ETFs more attractive to advisors, some providers have launched advisor-class ETFs, which, like mutual funds, pay annual trailing commissions ranging from 0.5% to 0.75%.

"Advisors who are more transaction-oriented and have been historically paid for their advice through trailer fees want and need that option if they're going to adopt ETFs," Gordon says. "If you don't have an advisor series, then it becomes difficult for them to get paid for their advice."

Toronto-based Claymore Investments Inc. became the first provider in Canada to offer advi-sor-class ETFs in 2006. (U.S.-based BlackRock Inc. has announced its intention to buy Claymore; see story on page 22.) More recently, XTF Capital and Horizons ETFs have introduced their own advisor-class funds. Of the 229 ETFs in Canada, as of December 2011, there were 56 advisor-class funds holding total AUM of $905 million. And executives at ETF firms expect the AUM in these funds to continue to grow.

Says Gordon: "Having the advisor series is going to facilitate the ETF adoption rate by advisors."

Other ETF providers, such as Toronto-based Vanguard Investments Canada Inc., are focused on appealing to fee-based advisors who don't rely on commissions — a segment of the advisory business that has embraced the low-cost investment vehicles in greater numbers.

These ETF providers are encouraged by the increasing popularity of fee-based compensation models.

"As the advisor earns a fee at the account level, it's to everyone's advantage that lower-cost investments actually make up the portfolio for clients," says Atul Tiwari, managing director of Vanguard, which launched its first six ETFs in December. "We think that's one reason we're seeing an increase in advisor usage of ETFs. And we believe that trend is going to continue."

Education is an important part of generating investor and advi-sor interest in ETFs. Even though ETF products have been around for about 20 years, there remains a lack of awareness of the products and the way they work.

"We think that the most important thing for the growth of the ETF market," Tiwari says, "is education."

As part of the effort to educate consumers on ETFs, three ETF providers, Horizons ETFs, Claymore and BMO, teamed up in May 2011 to form the Canadian ETF Association, a body that seeks to provide a single voice for the ETF sector in Canada. Other ETF providers are expected to join this year.

"We didn't feel ETFs were being represented properly by any existing organizations," says Atkinson, the association's chairman. "[We want to] make sure investors understand the merits of ETFs, and how to use them."

Because advisors are a trusted source of financial information for many Canadians, ETF providers are also focused on educating advisors. Providers regularly travel to branches and offer seminars that aim to educate advisors on both specific products and the merits of index investing in general.

"Educating advisors and the investing public on investing principles, the benefits of indexing and the benefits of ETFs is important," Tiwari says. "It's not all product-driven education or marketing. It's really more broadly-based education."

To ensure new advisors coming into the financial services industry are equipped with knowledge of ETFs, the Canadian ETF Association also provides educational materials to colleges that offer financial planning courses.

Says Atkinson: "We want to make sure that, from a grass-roots level, we're educating the next generation of advisors on the merits of ETFs early on, so that [ETFs get] a proper place in their books of business once they become advisors." IE