multiple flavours of ice cream

ETF providers and financial advisors often cite the lower costs of ETFs as a significant advantage over mutual funds. But as ETFs grow in nature and number – with new strategies and more active management – some costs have begun to edge upward.

And with costs continuing to be a key focus for clients concerned about performance, this trend is one you may need to address more often when considering ETFs.

John De Goey, portfolio manager with Toronto-based Industrial Alliance Securities Inc., says that the virtue of low costs remains the main attraction of ETFs; when that element begins to change, generally because of more active management, ETFs may become less attractive.

“I would rather have a low-cost, indexed mutual fund than a high-cost, actively managed ETF,” he says.

Pat Dunwoody, executive director of the Toronto-based Canadian ETF Association, says she doesn’t see upward pressure on the costs of ETFs. Some products will, by their nature, be more expensive, but she anticipates no change in what she calls “the race to the bottom.”

That’s partly due to competition, Dunwoody says, as well as the absence of the back-office costs and customer service that play a role in the costs of mutual funds. “Those costs won’t come into play [with ETFs] – ever,” she notes.

For De Goey, the issue is influenced by what he considers a distinct advantage of ETFs: the alternatives that help clients participate in a wider range of investment options than mutual funds. “Once you get past the first three-quarters of ETF products that might be relatively plain-vanilla, there’s another 25% available that do things, express [investing] opinions and viewpoints, and get exposure to asset classes that you just can’t get or do or find with mutual funds.”

The expanding use of fee-based compensation adds to the debate about costs and performance, Dunwoody says. The majority of advisors remain unable to use ETFs, partly due to the structure of their compensation, which generally includes some commissions-based revenue. “There’s no easy way to compensate the advisor for doing the work and selecting the product if the client’s not in a fee-based account,” she says.

But, as fee-based advisory practices grow in number, those advisors are likely to be looking for other ways to reduce costs for clients – and choosing ETFs can be key in that process. ETFs will be especially popular once advisors licensed by the Mutual Fund Dealers Association of Canada (MFDA) gain better access to ETFs. “Once we really get the MFDA advisors into the marketplace more aggressively, I think we’ll see a real shift [in ETF sales] over the next year or two,” Dunwoody says.

Although costs for ETFs remain mostly competitive, especially for classic, passively managed index funds, Dan Hallett, vice president with Oakville, Ont.-based HighView Financial Group, suggests that the rapid growth of newer, feature-laden – and often pricier – ETFs should be approached with some caution: “There is always a new [ETF-linked] index that’s really driven by whatever strategies the sponsor is creating.” The result, he adds, is that advisors can be left sifting through an array of choices that can sometimes look like change for its own sake.

“More choice doesn’t always result in better outcomes,” says Hallett, noting that advising clients to switch from actively managed mutual funds to acquire what are, in effect, actively managed ETFs is not necessarily helpful.

“It comes down to what the advisor and the client believe in,” Hallett says, noting that many clients take the time to inform themselves about their investing options and the costs of investing. “[Passive ETFs] are still a pretty easy choice because you can ignore the majority of the products out there. Then, you’re really just choosing among a very small group of index funds.”

If you and your clients prefer active fund management, you’re among the majority, in Hallett’s view, and the choice of fund then becomes more difficult as ETFs increase in number: “You have a lot of products to sift through. So, you’re back to the same challenges that advisors and investors have faced with mutual funds for a long time.”