Exchange-traded funds (ETFs) are versatile instruments that are finding favour with financial advisors as a tool for both core and niche strategies.
According to the results of a recent survey, almost 70% of advisors who use ETFs employ them to gain exposure to strategic niches when they use core/satellite investment strategies. A slightly smaller majority of users rely on ETFs to provide broad exposures to core asset classes.
The research was conducted by Toronto-based Credo Consulting Inc., in partnership with TC Media's Investment Group, in February and March 2015. The survey polled financial advisors who read Investment Executive and its Montreal-based sister newspaper, Finance et Investissement, both of which are publications in TC Media's Investment Group.
Among the 227 advisors who completed the survey, 123 use ETFs and 104 do not.
The results indicate that the advisor marketplace has taken to using ETFs for a multitude of strategies with respect to client asset management.
"ETF products are proliferating, and can be used to achieve a variety of exposures and to develop customized solutions that meet the needs of individual clients," says Hugh Murphy, managing director of Credo. "Some advisors use them solely for core, some use them to seek alpha through a satellite strategy, and some mix and match ETFs with other products such as mutual funds or individual securities."
The survey showed that more than 80% of ETF users expect ETFs will be a key part of the future investment product landscape, and almost 90% said ETFs appeal to clients because of their low management fees. A majority of advisors surveyed also said ETFs are a key factor in the transition of an advisor's business to a fee-based compensation system.
With low management fees, ETFs allow fee-based advisors to add their own annual advisory fee to a client portfolio and still offer value to the client. However, half of the advisors surveyed worry that ETFs have untested stresses or risks that are not faced by mutual funds.
"Trends such as the introduction of CRM2 and the growth of robo-advisors are putting pressure on advisors to justify the fees they pay," says Michael Keaveney, director of investment management, Canada, at Morningstar Research in Toronto. "The light is being shone on costs, and there is a lot of pressure for costs to come down."
Advisors agree that actively managed ETFs add value to the ETF product line, but there are some who say active management doesn't fit with ETF's value proposition of low fees. Active ETF managers have free rein to apply subjective decision-making skills in selecting and trading securities rather than tracking an index.
Although 70% of advisors surveyed agreed that active ETFs might offer added value relative to plain vanilla index-based ETFs, 37% specifically said the cost of active management is incongruent with an ETF, and 33% said active management outright defeats the purpose of an ETF. A slight majority of advisors feel that active management makes an ETF more appealing than a mutual fund. In terms of fees, actively managed ETFs tend to have higher fees than passively managed ETFs based on broad market indices, but lower fees than regular mutual funds.
Howard Atkinson, president of Toronto-based Horizons ETFs Management (Canada) Inc. and the largest manufacturer of active ETFs in Canada, predicts that many Canadian mutual fund companies and other major asset managers will soon be offering ETFs along with their existing stable of investment funds to take advantage of this increasingly popular, low-fee distribution channel.
Most advisors are using ETFs for a variety of asset exposures rather than favouring them for a specific category, the survey found. ETFs are popular for equity, high-yield, commodity and fixed-income exposures, and many advisors said that exchange rate trends were encouraging them to make use of currency-hedged ETFs.
"Currency fluctuations had a big impact on returns for Canadian investors in 2014, and that's still a concern in 2015," says Alain Desbiens, Montreal-based vice president of BMO Global Asset Management Inc., which offers fully currency-hedged as well as U.S. dollar denominated versions of several of the ETFs in its lineup.
"Currency movements touch both equity and fixed-income assets," says Desbiens. "We don't want to impose a point of view on currency to the investor or the investment advisor, but those with an opinion on the direction of the Canadian dollar can choose to hedge or not."