A shift in strategy

In the ever-expanding Canadian ETF universe, actively managed strategies are a growing presence in what was originally the exclusive preserve of passive indexing. At the end of Q1 2019, according to data compiled by New York-based Strategic Insight Inc., 263 of 701 Canadian-listed ETFs were actively managed. That’s almost four in every 10.

The proliferation of active ETFs has taken place across the board, from leading companies, to newer entrants among multibillion-dollar asset-management companies, to boutique firms. Active mandates encompass the full spectrum of asset classes, from core equity and fixed-income categories to specialty products investing in specific sectors or pursuing alternative strategies.

Asset growth, however, has been less dramatic. Active ETFs accounted for only 21% of the $172.9 billion in ETF assets under management as of March 31. According to the Canadian ETF Association, only two among the 20 largest ETFs were actively managed as of the end of May. Given this relatively modest market penetration, there remains scope for expansion.

“The active suite of products we have today – it’s not the final chapter,” says Mark Neill, head of ETFs for RBC Global Asset Management Inc. (RBCGAM). RBCGAM and market-share leader BlackRock Asset Management Canada Ltd. are co-operating in marketing and product launches through their strategic alliance. (Both firms are based in Toronto.)

While the bulk of BlackRock’s iShares ETFs are passively managed, the firm also offers rules-based active strategies and the fully active Dynamic iShares ETFs, the latter of which are based on mutual funds managed by Toronto-based 1832 Asset Management LP.

RBCGAM, for its part, is expanding its ETF suite beyond its current lineup of actively managed fixed-income and RBC Quant rules-based equity ETFs. “RBCGAM will absolutely be wholly focused on building out that active side of the product shelf,” Neill says. “We’re taking a methodical, consultative approach to what we’ve put to the marketplace, to make sure that every product we launch can add value, can solve problems and, hopefully, is innovative and helpful to the marketplace.”

Actively managed ETFs fall into one of several types. There’s strategic beta, which is non-passive indexing that employs criteria other than market capitalization or equal weighting. One of the oldest of this genre is iShares Canadian Fundamental Index ETF, launched in February 2006 as part of the ETF family formerly under the Claymore brand. That ETF’s stock weightings are based on factors such as cash dividends, free cash flow and total sales.

Other examples include the Mackenzie Maximum Diversification suite of ETFs, managed by Paris-based TOBAM on behalf of Mackenzie Financial Corp.; Fidelity Investments Canada ULC’s dividend-focused ETFs; CI Investments Inc.’s First Asset ETFs that track strategic beta Morningstar Inc. and MSCI Inc. indices; and Franklin Templeton Investments Corp.’s LibertyQT suite. (All these ETF manufacturers are based in Toronto.)

Some active strategies are rules-based and quantitative, but not linked to an index. That description applies to most of Toronto-based Purpose Investments Inc.’s equities lineup, in which the word “index” is conspicuously absent from ETF names. Purpose International Dividend Fund, for example, is actively managed, but employs equal weightings, a 20% sector cap and rankings for stable dividend yields and value factors. “We’re not going to be constrained by the index concept,” says Som Seif, Purpose’s president and CEO. “Rather, we’re going to focus on [doing] that really well, but also implementing risk-management policies and procedures across everything we do.”

Other examples of factor-driven non-index strategies include AGF Investments Inc.’s lineup of 10 AGFiQ ETFs and Vanguard Investments Canada Inc.’s four global ETFs. The Vanguard ETFs screen for liquidity, minimum volatility, momentum or value. (Both firms are based in Toronto.)

Elsewhere, active ETFs that employ covered-call option writing also have elements of passive investing. These ETFs typically hold equally weighted stock portfolios that are rebalanced periodically, although Toronto-based BMO Asset Management Inc. also offers some ETFs with holdings weighted according to dividend yields. Other notable providers of covered-call ETFs are CI, Oakville, Ont.-based Harvest Portfolios Group Inc. and Toronto-based Horizons ETFs Management (Canada) Inc.

The purest forms of active ETF portfolio management, and the ones closest to traditional mutual funds, are those with fully discretionary investment mandates. These types of active mandates have the greatest potential for expansion in ETF lineups by companies that can either draw on their in-house investment teams or hire subadvisors.

Fully active management is entrenched in the fixed-income categories, for which demand has been fuelled by the “substitution effect.”

Financial advisors are increasingly placing bond ETFs in clients’ portfolios rather than investing directly in bonds, for which bid/ask spreads may be wide and inventories scarce for retail accounts.

Among the most extensive lineups of active fixed-income ETFs is that of Horizons, which the company began building in 2009. “We saw all of these inefficiencies in the fixed-income marketplace,” says Steve Hawkins, president and CEO, adding that there were “a lot of opportunities for active fixed-income to outperform traditional benchmark fixed-income.” Lacking the necessary internal investment expertise, Horizons hired Fiera Capital Corp. as subadvisor to manage Horizons’ bond and preferred share ETFs and AlphaFixe Inc. to manage its senior loans ETF. (Both Fiera and AlphaFixe are based in Montreal.)

The bank-owned and independent providers that manage traditional mutual funds can leverage their internal investment capabilities for their active fixed-income ETFs. Bank of Montreal and Royal Bank of Canada both are well represented in the active fixed-income space, while Toronto-based CIBC Asset Management Inc. launched a pair of active bond strategies when it entered the ETF market in January. Among the independents, Mackenzie’s active fixed-income ETFs are managed by the same internal team that manages the firm’s mutual funds. Similarly, Franklin Templeton draws on internal portfolio managers in Calgary and from its affiliated portfolio managers in California.

First Asset Management Inc. has capitalized on being taken over by CI Financial Corp. in 2015. This facilitated the launch of more First Asset fixed- income ETFs, which are managed by either Signature Global Asset Management or Marret Asset Management Inc. (both fellow subsidiaries of CI). “If you look at the number of portfolio-management groups within CI, [they] really allowed us to expand on that part of our ETF lineup with a lot more ease than had CI never acquired us,” says Peter Tomiuk, senior vice president, ETF strategy, on CI First Asset’s sales team.

Far less of a presence throughout the industry are the fully active equity mandates that have been mainstays of mutual fund sponsors. The large actively managed core equity mandates that CI’s Signature team manages have no ETF equivalents at CI First Asset. “It’s not to say we wouldn’t expand more on our equity side on the full discretionary active side,” says Tomiuk. “But without a doubt, I think we were able to, a couple of years ago and even now, identify more of a need on the active fixed-income side.” He adds that there will be “a real appetite” for some of the active CI equity strategies that currently aren’t available in ETF form.

Rules-based equity mandates, rather than fully discretionary ones, are the approach taken by Toronto-based Invesco Canada Ltd. since it began offering ETFs in 2011. ETF and mutual fund portfolio managers don’t always have the same needs, says Jasmit Bhandal, vice president and head of ETF product strategy and development at the firm. Sometimes, she adds, “people want very sharp tools, and more granular splits of certain asset classes,” which is less true in the mutual fund world.

Bhandal leaves the door open to Invesco ETFs expanding into the traditional bottom-up stock-picking strategies of its equity mutual funds. “We’re always evaluating and trying to determine what clients want, and what vehicles they want it in, because, frankly, we’re vehicle-agnostic. If clients want [an investment strategy] in an ETF, we’ll create it in an ETF.”

At AGF, meanwhile, there’s no overlap between its mutual fund and ETF lineups, even though some of its investment personnel manage both product types. “Within the ETF space, a lot of the times it is the advisor looking for clean building blocks to create portfolios, models and strategies that they can rebalance on their own, based on their own beliefs and biases,” says Florence Narine, senior vice president, product. “We are always revisiting the decision whether or not our existing fundamental strategies within the mutual fund wrapper make sense within an ETF vehicle. But we took the approach of [asking], ‘What is that advisor and client aiming to do with an ETF?'”

Narine cites the Canadian Securities Administrators’ client-focused reforms as creating an advantage of maintaining distinct product lines between ETFs and mutual funds. Doing so, she says, creates clarity for advisors, who don’t have to decide between pricing and other differences between the two structures.

One of the trends noted in the ETF Report, published in June by BMO Asset Management Ltd. (operating as BMO Global Asset Management [BMOGAM]), is the use of active management in less efficient markets. This has proven to be the case for ETFs specializing in the cannabis industry, with active ETFs managed by Purpose and Toronto-based Evolve Funds Group Inc. outperforming the sector as a whole. “With so much volatility in that market [and] so many developments taking place from a rules and regulations and government policy perspectives, we felt that was also [an industry] that merited active management,” says Raj Lala, Evolve’s president and CEO.

But ETF providers must be mindful of the challenges posed by intraday trading in less efficient markets. “What’s most important when you put a mandate in an ETF wrapper is thinking about that exchange experience, and making sure the liquidity is there and the underlying spreads are going to be at a reasonable level,” says Mark Raes, managing director and head of product with BMOGAM.

Holdings disclosure also may be an issue for some active portfolio managers, but perhaps less so than before. “By and large, the market has overcome that, and true active ETFs that have come out have been successful,” Raes says. It helps that disclosure rules for Canadian ETFs are the same as for mutual funds and daily disclosure of ETF holdings isn’t mandatory.

Recent BMOGAM ETF launches include fully active Canadian equity and North American equity funds, subadvised by Calgary-based SIA Wealth Management Inc. Active ETFs are “another opportunity to distribute our product, and it aligns very well with what advisors and portfolio managers are doing, which is building more ticker-based business into their books,” says Raes. “We want to be right there and walk hand in hand with that.”