Table: Canada’s top 10 ETF providers, 2017

The ETF industry in Canada is growing at a scorching pace. Not only is the volume of assets flowing to ETFs continuing to soar, but the range of fund mandates is expanding rapidly, as are the numbers and types of firms that provide ETFs.

That growth is creating a host of opportunities – and challenges – for financial advisors and their clients, who are still getting to know this relatively new investing vehicle. There’s no question, however, that ETFs have captured the investment industry’s full attention and that strong growth is likely to continue.

Says Michael Cooke, senior vice president and head of ETFs with Mackenzie Financial Corp.: “Every asset manager has an ETF strategy. They may be introducing their own ETFs; they may be acquiring an ETF provider; or they may have made a conscious decision to stay away. But ETFs are too big to ignore.”

Numbers tell the story. In 2017, there were massive net inflows of $25.8 billion into Canadian-listed ETFs – smashing all previous records and bettering the previous sales record set in 2016 by more than 50%, according to figures provided by National Bank Financial Inc. (NBF) of Toronto. Propelled in part by buoyant financial markets throughout most of last year, assets under management (AUM) in Canadian ETFs of $147.1 billion, as of Dec. 31, 2017, rose by a robust 30% year-over-year. Although the $1.5 trillion in Canadian mutual fund AUM dwarfs that of ETFs, the rate of growth in ETF AUM is the greatest since 2009, when markets recovered strongly following the 2008-09 global financial crisis.

Despite the return of volatility and heightened nervousness in markets earlier this year, the outlook for ETFs remains strong. Canadian-listed ETF AUM rose to a new high of $150.1 billion as Feb. 28.

Explaining these massive inflows is an inexact science, but both providers and advisors are keying on a few consistent trends. For one, the easy tradeability and transparency of ETFs is attracting many investors who typically buy stocks and bonds directly.

In addition, the generally lower management costs of ETFs in comparison to mutual funds appeal to investors looking for baskets of securities to provide diversification and market resilience in their portfolios. Low costs also attract increasing numbers of advisors who have switched to fee-only advice and seek ways to contain costs for their clients.

Furthermore, as the variety of ETF options proliferates, these new investment possibilities are intriguing investors. “It’s still a nascent industry, with new players, products and trends emerging,” says Daniel Straus, analyst, ETFs and financial products, with NBF, who adds that growth in the industry continues to be “eye-popping.”

Competition for new investors is stiff. As providers are acutely aware, a record 169 ETFs were launched last year, pushing the total number of Canadian-listed ETFs to 648 as of Dec. 31. To be sure, not every ETF is a success, and these numbers include 22 ETFs that were closed down during the year, according to NBF. But the deluge of new options continues in 2018, with another 36 ETFs added in the first two months of this year.

Even more telling, the number of firms now providing ETFs has soared to 28 compared with 17 at the end of 2016 and a mere seven only five years ago. “The biggest story in ETFs is the massive growth in the number of providers,” says Mark Noble, senior vice president, sales strategy, with Toronto-based Horizons ETFs Management (Canada) Inc. “There’s been a seismic shift in the asset-management industry as traditional fund companies that may have seen ETFs as a threat now are entering the business.”

New entrants last year include recognizable names such as Manulife Investments, a division of Manulife Financial Corp.; Franklin Templeton Investments Corp.; AGF Investments Inc.; and PIMCO Canada Corp. (all based in Toronto); as well as Lévis, Que.-based Desjardins Group. Toronto-based Sun Life Global Investments (Canada) Inc. (SLGI) dove in when it purchased Mississauga, Ont.-based Excel Funds Management Inc. and its stable of mutual funds and ETFs in late 2017. However, SLGI announced in March that it’s terminating Excel’s ETFs as the firm refines its ETF strategy.

Existing distribution networks can be a major advantage for this group. Mackenzie, which launched its first ETFs in late 2016, garnered about $1.3 billion in ETF AUM by the end of 2017 and sales momentum is accelerating, says Cooke. Giant wealth managers, such as banks, as well as insurance and mutual fund companies, can capitalize on their long-established relationships with the advisor network.

In some cases, these firms also are introducing ETFs that make use of existing investment-management teams or offer similar strategies to their suite of mutual funds. Says Straus: “Mutual fund players getting into ETFs have an advantage over pure startups. [The former] have a lot of tools in the box already, including a distribution force, well- recognized fund managers and deep pockets.”

Another attention-grabbing trend is the entry of smaller names, many offering specialized niche products. This group includes Evolve Funds Group Inc., Redwood Asset Management Inc., Galileo Global Equity Advisors Inc., Equium Capital Management Inc. and Arrow Funds Capital Management Inc. (all based in Toronto). Evolve, for example, offers gender diversity and cybersecurity themed ETFs (see story on page 22), while Arrow has launched an actively managed fixed-income ETF that uses interest rate-hedging strategies.

These recent additions, when added to the many traditional ETF mandates that exist, are contributing to a significant increase in choice for investors.

“ETFs are an efficient way to target exposures in a wide variety of asset classes,” says Kevin Gopaul, chief investment officer and head of ETFs with BMO Asset Management Inc. (BMOAM) of Toronto. “Investors can target the specific exposures they need to match their investment objectives and needs precisely, from low volatility to international exposure.”

Still, new market entrants, big and small, have many challenges, with only four firms holding almost 90% of ETF AUM in Canada. The granddaddy remains BlackRock Canada Asset Management Ltd.’s iShares division, with $59.8 billion in AUM as of Dec. 31. Nipping on its heels is BMOAM, with $46.5 billion in AUM, followed by Vanguard Investments Canada Inc., with $13.7 billion, and Horizons, with $9.1 billion.

These four players also accounted for 72.1% of net ETF inflows in 2017. However, iShares is giving up market share, while BMOAM is rapidly gaining ground: the latter’s 2017 inflows of $10.3 billion significantly outpaced the $2.9 billion in AUM that iShares brought in. (See story on page 10.) Toronto-based RBC Global Asset Management Inc.(RBCGAM) is also coming up fast, with net inflows of $2.3 billion in 2017, making it the fifth-largest Canadian ETF provider at yearend, with AUM of $4.7 billion.

Not every entrant will succeed, and some marketwatchers foresee potential for consolidation. Upstart Evolve recently acquired Toronto-based Sphere Investment Management Inc.’s five ETFs and consolidated that lineup to three, while Toronto-based WisdomTree Asset Management Canada Inc., a division of New York-based ETF giant WisdomTree Investments Inc., acquired Questrade Wealth Management Inc.’s ETFs in late 2017.

“There have been a lot of new entrants, but the challenge is to compete against the biggest players,” says Rudy Luukko, investment funds and personal finance editor with Morningstar Canada in Toronto. “We could see more consolidation, even as the industry is growing.”

At the same time, the nature of new product offerings is shifting. There have been fewer introductions of ETFs based on popular, market capitalization-weighted indices, although that group still accounts for most of the Canadian market, with more than 70% of equities-based ETF AUM and 70% of inflows at yearend. Instead, both big and small players alike are innovating with ETFs by offering varying degrees of active management – from customized rules-based and quantitative strategies known as “smart/strategic beta” all the way to the full discretionary active- management mandates that characterize many mutual funds.

For example, Evolve, Harvest Portfolios Group of Oakville, Ont., and Toronto-based Purpose Investments Inc. (and its subsidiary, Redwood Asset Management), are targeting specialized strategies and niche ETFs, jumping on such hot trends as marijuana, blockchain and bitcoin.

Horizons also launched innovative and theme-based products within the past year, including: Horizons Active AI Global Equity ETF (TSX: MIND), which focuses on artificial intelligence technology; Horizons Marijuana Life Sciences ETF (TSX: HMMJ); and Horizons Robotics and Automation Index ETF (TSX: ROBO).

“We see areas in the market in which ETFs, with some degree of active management, can be beneficial,” says Raj Lala, president and CEO of Evolve. “Even within the [strategy] of passive indexing, there still are some areas around the globe that are not well covered by ETFs.”

Alternative strategies are another new category. Horizons and Purpose have been trailblazers in this arena, and Mackenzie offers Mackenzie Portfolio Completion ETF (TSX: MPCF). Other providers such as BMOAM and First Asset Investment Management Inc. of Toronto are contemplating introducing products in this area as investors wary of erratic markets become more concerned about the downside protection that alternative strategies can offer.

Robo-advisor firms, including those owned by big banks, such as Bank of Montreal and Royal Bank of Canada, also are mining investor appetite for no-frills, asset-allocation services. Robo-advisors’ standardized, low-cost portfolios generally offer ETFs only.

As well, robo-advisors such as Toronto-based Smart Money Capital Inc., Justwealth Financial Inc. and Invesco Canada Ltd.’s advisorDUO are hooking up with financial advisory firms, including members of the Mutual Fund Dealers Association of Canada, to provide the dealer firms with trading access to ETFs. (See story on page 14.)

There are likely to be more alliances, says Gopaul: “We will see more partnerships between large wealth-management firms and the robo- advisors. The banks are seeing a need to offer low-touch, low-cost advice. It’s in the business plan of financial [services] institutions to be more digitally advanced. Robo-advisors use ETFs in their portfolio construction, and there is a cost advantage to that.”

Although ETFs have infiltrated virtually every financial asset class – from emerging-market bonds to gold to liquid alternatives – the most popular asset class remains equities. By yearend, equities-based ETFs made up $88.1 billion, or roughly two-thirds of Canadian ETF AUM. Comparatively, fixed-income accounted for $49.1 billion in AUM.

However, even though fixed-income ETFs are newer to the market, they’re catching up quickly, with net inflows of $10.5 billion last year. Given that the market cap of the global bond market is more than double that of the global stock market, the potential for fixed-income growth in Canada is massive. Already, fixed-income ETF investors have a smorgasbord of choices, including government, corporate, high-yield, floating-rate loans and laddered bond portfolios, as well as convertible bonds, global and emerging-markets bonds, and preferred shares.

Costs are a key driver in this segment. Given the low interest rate environment, in which the impact of product management fees can be particularly corrosive to bond returns, the low fees ETFs offer are particularly attractive. Active strategies have been popular in fixed-income products, capturing 41% of fixed-income inflows last year, according to Straus. Popular products include active bond ETFs from PIMCO and First Asset, as well as active preferred share-based ETFs from RBCGAM, Horizons and Dynamic Funds (a division of 1832 Investment Management LP of Toronto).

“Individual fixed-income securities historically have traded in an opaque and illiquid market in Canada,” says Noble, “However, ETFs offer a transparent, low-cost and easily tradeable product that’s appealing to both retail and large institutional investors.”

A recent BMOAM report predicts the industry’s expansion will continue, with Canadian ETF AUM approaching $400 billion in the next five years. That could reshape the investment funds business, on many fronts.