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ETF Guide 2016

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The popularity of international ETFs is growing rapidly as investors look for greener investment pastures

By Susan Yellin | May 2016

Disappointed with homegrown equities' performance and a lacklustre loonie, many Canadian investors are looking for ways to boost their portfolio returns through investing in stronger economies and more buoyant stock markets. Increasingly, these clients are turning to international equity ETFs.

"There is definite evidence that Canadians are going international," says Tyler Mordy, president and chief investment officer at Forstrong Global Asset Management Inc. in Toronto. "The pickup in interest has been enormous."

Industry statistics back that up. Last year, Canadians purchased $16.5 billion in ETFs - a record year - across all asset classes, bringing total assets under management (AUM) to $89.5 billion, according to the Canadian Exchange-Traded Fund Association. However, Canadian exchange-listed ETFs that invest internationally outshone their domestically focused counterparts, with U.S., international markets and emerging markets collectively attracting $6.5 billion in AUM compared with Canadian-focused ETF inflows of $2.5 billion.

According to Toronto-based Investor Economics Inc.'s analysis, globally focused ETFs' strong inflows mean AUM in foreign-investment ETFs is catching up rapidly to Canada-focused ETFs. As of Dec. 31, 2015, U.S./international/emerging markets equity ETFs held $21.8 billion in AUM, up by more than 50% from $14.2 billion at the end of 2014, while Canadian equity ETFs' collective AUM fell slightly to $26.4 billion from $27.1 billion in the same periods.

Investors are shifting into international ETFs because of relatively poor performance of Canadian equities vs international equities, says Mark Noble, senior vice president, sales strategy, at Horizons ETFs Management (Canada) Inc. of Toronto. "Over the past few years, Canada has been one of the worst markets to be invested in," Noble says, "whereas you've generated relatively positive returns by being invested in the U.S. and in international markets."

He notes that Horizons' actively managed global dividend international ETF - Horizons Active Global Dividend ETF - is one of the firm's best-selling ETFs, raising $105.3 million in AUM in 2015, an increase of more than 30% over 2014. (Subadvisor on that ETF is Toronto-based Guardian Capital LP.)

International equity ETFs usually focus on large- capitalization companies in developed markets such as Europe, Japan, Australia and the U.S., Noble says. This class of ETFs offers exposure to a greater variety of business sectors than the resources- and bank-dominated Canadian stock market does. (Financials and energy alone account for roughly 55% of the capitalization of the S&P/TSX composite index.)

Mark Yamada, president and CEO of PUR Investing Inc., which is a subadvisor to Horizons' model portfolio program, sees a benefit for Canadians in broadening their lens to look at sectors on a global basis and analyzing how they will be affected by economic trends. "We may not be able to play to countries so much as sectors that might be at the right point in that economic cycle," he says.

Although some international ETFs are actively managed and don't track world stock market indices faithfully, Noble says, most international equity ETFs are benchmarked against the MSCI world index, which covers a wide range of countries and industries. Horizons Active Global Dividend ETF, for example, which can invest anywhere in the world, is overweighted in consumer staples, telecommunications and health care, he says, and underweighted in financials and energy.

Country selection, Mordy says, is top of mind for some international investors, with commodity-importing countries performing better than commodity-exporting countries - such as Russia and Canada - during the recent period of sagging energy prices. "I think there are a lot more opportunities for active country selection. Evidence would suggest that investors are not accessing those opportunities just yet."

Some investors may believe that if they go global, their increased returns might come at the expense of increasing risk. However, Mordy says, investors should instead be aware of global trends and realize they are actually better off managing risk by going international.

Mordy and his team select ETFs for their portfolios by identifying dominant global themes, then allocating assets to opportunities the team discerns in "the right areas of the world." Mordy believes there will be a major shift away from "siloed" stock-picking and toward multi-asset class, globally diversified portfolio management using ETFs.

There are risks that investors need to be aware of when purchasing international ETFs, the most notable of which is currency risk. Noble says due diligence on the kind of hedging strategy used by an ETF is necessary to determine what, if any hedging exposure is being used and whether that is in sync with advisors' and their clients' view on the currency

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