Having gained popularity since their launch in 2013, ETF series drew the attention of regulators this year, who are asking whether their fees are fair — and whether they create conflicts of interest.
An ETF series is a class of units of a mutual fund that trades on an exchange. It holds the same portfolio and follows the same investment strategy as the underlying mutual fund. The key difference is that instead of being purchased or redeemed through the issuer at the fund’s net asset value after market close, the ETF series can be traded throughout the day like any other ETF.
According to Laurent Boukobza, vice-president and ETF strategist with Mackenzie Investments, offering an ETF series allows mutual fund issuers to “reduce some of the fixed costs associated with maintaining two separate structures. It also lets them present a performance track record for the strategy before it’s launched as an ETF series.”
ETF series also make certain strategies more accessible to investors, he added.
“Investors using discount brokerage platforms can easily buy an ETF series, whereas purchasing a traditional mutual fund on the same platform can be more complicated,” Boukobza said.
But there’s more nuance to these products.
Operational and fee concerns
Like non-listed mutual fund series, ETF series share the operating costs associated with investor purchases and redemptions within the fund — costs that don’t affect standalone ETFs.
“Exchange-traded series that transact with [authorized participants] (APs) on an in-kind basis would be expected to have lower portfolio transaction costs, as such costs are borne by APs and passed on to transacting investors,” the Canadian Securities Administrators (CSA) noted in a consultation paper on ETF regulation published in June.
However, the CSA points out that the operating expense ratios of ETF series and non-listed series are typically identical, even though operating costs for the former are generally lower.
Boukobza agreed: “Typically, ETF series charge the same fees as F-series mutual funds and provide the same exposure as other series within the same underlying fund.”
Then there’s the issue of rebalancing costs.
“A fund offering both series may not be able to use in-kind transactions to the same extent as a standalone ETF to rebalance its portfolios, resulting in higher portfolio transaction costs that are allocated to both series,” wrote the CSA. “This could lead to higher portfolio trading costs that affect both series.”
The regulators also raised a broader question: Could a fund manager “act in a way that prioritizes the interests of one series over another?”
That’s a real risk, said Prerna Mathews, vice-president of ETF products and strategy with Mackenzie Investments and co-chair of the Canadian ETF Association (CETFA) board. She clarified that she’s expressing Mackenzie’s view, not that of CETFA.
“An ETF series pools the trading costs within the underlying fund, which exposes investors to the risk of large inflows and outflows that can undermine the performance of other unitholders,” she said.
Cost clarity
In its consultation, the CSA also asked whether the costs between ETF and non-listed series could be better separated, “so that the former operate more like standalone ETFs.”
According to Mathews, some general costs — such as taxes on foreign capital gains — must be shared across all series. Others, however, apply only to non-listed series.
“More detailed accounting will be needed to ensure that ETF series aren’t charged expenses that don’t belong to them,” she said.
The CSA also asked whether investors should receive additional information outlining the differences between an ETF series and a traditional ETF. Mathews believes they should.
“Such disclosure — including a summary of key risks — is necessary,” she said.
Alain Desbiens, vice-president, ETFs with BMO Global Asset Management, agreed, noting that upcoming total cost disclosure requirements for investment funds will require this kind of transparency.
The CSA also contemplates whether switching between ETF series units and non-listed series units should be prohibited. Most issuers already restrict such conversions, but some still allow them.
Eli Yufest, CEO of CETFA, doesn’t see the need for outright restrictions.
“What matters is ensuring that conversions between series are handled fairly,” he said. “Investor protection can be achieved through transparency rather than through prohibitions.”
This article was originally published in our sister publication Finance et Investissement. It was translated from French.