ETFs continue to grow in popularity and set new records for net creations. These products no longer merely compete with mutual funds — they’re now increasingly integrated into mutual fund assets, and even into other ETFs.
“Issuers are showing more and more creativity in finding new users and new applications for their ETFs, which are even being nested within other products,” CIBC Capital Markets noted in a June report.
This kind of ETF integration within mutual funds would have been unthinkable when ETFs first appeared about 30 years ago, said Daniel Straus, head of ETF and financial products research and strategy with National Bank Financial.
“At the outset, ETFs were seen as being ideologically opposed to mutual funds — even as disruptive rivals,” he said. “Today, there’s a much stronger symbiosis between these two investment vehicles.”
Dan Hallett, vice-president of research with HighView Financial Group, agrees.
“It’s increasingly common to include ETFs within a mutual fund, or even in a fund-of-funds structure, such as an asset-allocation portfolio,” he said.
According to CIBC, more than 20% of Canada’s roughly 1,600 ETFs are now held by mutual funds, with another 8% held by ETF-of-ETF products.
Part of this growth stems from large fund companies now offering their own full ranges of ETFs and integrating them into other products, the CIBC study notes.
ETF structure drives integration
The popularity of ETFs — along with the efficiency and flexibility of their structure — is also fuelling their continued growth within mutual funds. Among Canada’s five largest ETF issuers, between one-fifth and two-thirds of total ETF assets are now embedded within other retail investment vehicles, CIBC highlighted.
“We have a very wide range of mutual funds that include ETFs within their assets,” said Erika Toth, director and team lead, ETF distribution for eastern Canada with BMO Global Asset Management (GAM), noting that her firm has offered such products for about 15 years. “It fits very well with the needs of portfolio managers and investors.”
Straus echoed that sentiment.
“Advisors and investors — particularly the more sophisticated ones — understand that this is a way to gain highly diversified and low-cost exposure to all types of investments,” he said.
He also noted that younger investment advisors, who have inherited client books from retiring colleagues, have restructured some portfolios to include more ETFs.
Furthermore, integrating ETFs into mutual funds allows advisors who might otherwise lack access to ETFs to offer them indirectly to their clients.
“Some mutual fund representatives don’t have direct access to ETFs, so they can work around that limitation by offering mutual funds composed of ETFs,” Hallett explains.
That said, he added, “If they do have ETF access, it’s preferable to invest directly in ETFs rather than through mutual funds that hold them.”
Mutual funds’ ETF holdings
According to CIBC, ETFs represented 4.7% of Canadian mutual fund assets in 2023, compared with about 2% in 2018. Among mutual fund types, balanced funds tend to have the highest ETF allocations (7.9%), while equity and bond funds each have around 2.4% exposure.
ETF use within ETFs is even more pronounced, particularly in balanced funds that use the issuer’s own ETF lineup as underlying holdings.
Overall, the two most common uses of ETFs within Canadian mutual funds are for fixed-income exposure and access to foreign equities.
Given the strong growth trajectory of ETFs, CIBC suggests there’s still room for expansion within mutual funds. The study notes that about one-quarter of mutual fund assets under management (AUM) currently consist of “other mutual funds” — roughly five times the AUM of ETFs currently held in mutual funds.
Vertical integration
Much of the domestic ETF growth inside mutual funds is driven by issuers that have both strong ETF manufacturing capabilities and robust mutual fund distribution networks — in other words, firms with vertically integrated operations.
Mutual fund providers also tend to favour their own ETFs when building mutual funds that hold ETFs.
“Fund providers are hesitant to buy ETFs from ‘competing’ issuers,” CIBC noted. “Almost a third of ETFs held in Canadian mutual funds are external; i.e., not from their own fund family. In the case of ETFs, virtually none of the ETFs within ETFs are external.”
BMO GAM, for example, primarily uses its own ETFs within the roughly 30 mutual funds it offers that are composed of ETFs.
“That’s because we have one of the largest ETF ranges in the country, so we don’t often need to look elsewhere,” Toth explained “That said, we sometimes do when we lack a specific product a manager is seeking.”
Another reason to stick with in-house products, she added, is cost: “If we were to use another issuer’s product, the investor would end up paying an additional layer of management fees.”
This article was originally published in our sister publication Finance et Investissement. It was translated from French.