exchange-traded funds, woman with tablet

Educating clients about ETFs may seem like a daunting task, but it doesn’t have to be. That’s because ETFs still retain many of the features of mutual funds even though they sometimes involve what can seem like a blizzard of technical jargon.

“The technical features of ETFs are not a barrier [for clients who know mutual funds.] They are both diversified baskets,” says John De Goey, portfolio manager with Toronto-based Industrial Alliance Securities Inc. “You get an asset mix that suits your time horizon and your risk profile; you rebalance from time to time; and beyond that, you just let it go. You don’t need to understand the finer points of how it works. You just need to know it works and you need to use it.”

For many financial advisors and their clients, the basic considerations when making decisions about investments will not change much when ETFs are considered. Keeping it simple is what works. Says Rohit Mehta, president of Toronto-based First Asset Investment Management Inc.: “If I were an advisor, I’d say to a client: ‘An ETF, in its simplest form, is a mutual fund that trades on an exchange’.”

More important, the decision to use ETFs in clients’ portfolios has to be integrated into a broader financial plan that includes a choice of investment types, such as stocks and bonds, Mehta says. The package the investments arrive in is not the main consideration, he adds: “Change just for the sake of change [to add ETFs to a portfolio] doesn’t make sense.”

In cases for which there are good reasons to make a switch, they should be explained. For example, advisors may wish to move clients into a specialized ETF because it offers easier access to certain types of investments or lower costs.

The initial discussion with a client might take the following form, Mehta suggests: “This is a product suite, or investment approach, that’s only offered in an ETF.” Examples then can be given, such as ETFs that focus on particular sectors, regions or highly specialized indices that would be difficult or more expensive to replicate in other forms.

The type of investors you work with also is important, Mehta adds. Sophisticated investors who are comfortable buying stocks directly may want more information than less engaged clients who are happy to have you guide them. The latter group of clients, he says, “don’t really want all the details.”

Darren Coleman, senior vice president, private client group, and portfolio manager with Coleman Wealth in Toronto, which operates under the Raymond James Ltd. banner, is emphatic about the primacy of disciplined planning and investing. But discipline also can be “boring” for clients, he says.

One feature of ETFs that can help your clients stick to their plans is the “new” factor associated with ETF products, which can help create curiosity among clients, Coleman says. This heightened interest then can be used to create a “teachable moment” about the pros and cons of passive vs active investing.

Says Coleman: “We say, ‘All [an ETF] is is a box. Let’s look at the features of the box. For example, what does it cost and is it active or passive? In other words, are we just following a software program or are we paying a team to have discernment about which investments we should be in? Do we think there is value in paying or do we think it’s better to just use the algorithm?'”

Many clients also like to know what they’re buying, and the transparency of ETFs makes it easier to explain which investments they hold.

“It’s very important that clients understand the quality and the nature of the investments they’re owning,” Coleman says. “Most people settle down when they do that. They’ll see Royal Bank [of Canada] or PepsiCo [Inc.] or McDonald’s [Corp.], and they’ll go, ‘OK, now that’s real to me’.”

Explaining the details of highly specialized ETFs may present more challenges. That’s particularly so for the category of ETFs that use a strategy known variously as factor-based, smart beta or strategic beta. This highly focused strategy is built around specialized market indices and has proven popular in recent years. According to some estimates, ETFs that incorporate this strategy now make up 25%-30% of assets under management in the Canadian market.

Darnel Miller, director, ETF capital markets and institutional sales, with Manulife Investments, a division of Manulife Financial Corp., in Toronto, notes that all of the firm’s ETF offerings, which launched in April 2017, fall into this category. (The ETFs Manulife Investment offers use strategies that Dimensional Fund Advisors Canada ULC, the Canadian subsidiary of Texas-based Dimensional Fund Advisors LP, has developed.)

One of the easier ways to describe ETFs that use this strategy, Miller says, is to compare them to other types of funds. Those that incorporate these strategies are neither completely passive, as are about two-thirds of Canadian ETFs, nor actively managed, like some ETFs and most mutual funds.

“I describe ‘strategic beta’ as a combination of [passive and active portfolio management],” Miller says. “It follows an index, but it’s a [specialized] index that tends to have a different outcome for investors. It could be [based on] low volatility or dividends [for example]. In our case, it’s focused on higher expected returns, so there’s the ability to outperform the market.”