Technology and growing competition mean mutual funds and ETFs are moving closer to each other in price and product features. Mutual fund fees are dropping and ETFs now provide exposure to a growing array of investment strategies and asset classes.
Although both markets are poised to enjoy healthy growth in 2018, ETF assets under management (AUM) is expected to rise at a faster pace from that market’s smaller base. The ETF market is broadening, with choices expanding beyond products that mimic benchmark indices.
As the ETF market matures, ETFs offer growing access to fixed-income securities, alternative strategies and active portfolio management for both institutional and retail investors.
“Product proliferation is the ultimate consequence of greater awareness and rising demand for ETFs,” says Carlos Cardone, senior managing director with Strategic Insight Inc. in Toronto. “A lot of new providers and products are entering the market at a fast pace.”
The number of ETFs in Canada stood at 550 on Oct. 31, 2017, up by 95 ETFs from a year earlier, according to statistics compiled by the Canadian ETF Association (CETFA). As well, the number of ETF product sponsors in Canada has risen to 28, up from 18 a year ago. Several of these sponsors are companies that traditionally sold mutual funds, including AGF Management Ltd., Mackenzie Financial Corp. and Manulife Financial Corp. (all based in Toronto). These firms are expected to make more of their traditional mutual fund strategies available through ETFs in 2018.
“Any major fund companies that don’t already have ETFs are thinking of [entering the ETF market] and we could see more [ETFs] coming to market,” Cardone says.
At the same time, individual ETF products and providers that don’t attain economies of scale could disappear. For example, last year, Evolve Funds Group Inc. took over the ETF assets of Sphere Investment Management Inc. (both of Toronto). And there could be further consolidation, says Dan Hallett, vice president and principal with HighView Financial Group in Oakville, Ont.
AUM held in ETFs sponsored by Canadian companies swelled to $141.3 billion as of Oct. 31, according to CETFA, a 30% jump year-over-year. But, despite this heady growth, ETFs still are dwarfed by their mutual fund cousins. Mutual fund AUM, as measured by the Investment Funds Institute of Canada, was $1.47 trillion as of Oct. 31, up by 10% year-over-year. This means that ETF AUM still is less than a tenth of the AUM held in mutual funds.
“On both the fixed-income and the equities side, ETFs are displacing the use of individual securities rather than displacing mutual funds,” says Michael Cooke, senior vice president, ETFs, with Mackenzie Financial. “ETFs give you exchange tradeability and diversification – the best of both worlds.”
Most new ETF products in 2018 are likely to focus on customized, rules-based and quantitative strategies. A growing number of ETFs will offer the fully discretionary, active management that characterizes mutual funds as issuers seek openings in a competitive and crowded marketplace.
“If you’re risk-averse, there are low- volatility ETFs. If you want income, there are dividend-based ETFs,” Cooke says. “If you’re interested in a specific geographical region or sector, you can target precise exposures.”
ETFs could gain a growing share of the overall flows into investment funds this year if recent trends continue. ETFs had net inflows of $21 billion for the 10 months ended Oct. 31, more than half the value of mutual fund net sales of $41 billion.
The rise in the number of financial advisors operating fee-based practices will fuel demand for low-fee products such as F-series mutual funds and ETFs in 2018. There also is growing demand for low-fee, D-series mutual funds for clients of discount brokerages that offer no advice. The ascent of robo-advisors, which also compete on a platform of low cost and little advice, is giving rise to a new sales channel for ETFs.
“Investment returns are not as rich as in the past, and this creates downward pressure on fees,” says Rudy Luukko, investment funds and personal finance editor with Morningstar Canada in Toronto.
Although robo-advisors still are relatively small in terms of assets under administration, they’re gaining increasing traction through partnerships with full-service advisors. Robo-advisors rely on ETFs as the components for ready-made portfolios designed to suit a variety of risk tolerances and investment objectives.
In addition, ETFs may become accessible to advisors at firms licensed by the Mutual Fund Dealers Association of Canada (MFDA). So far, MFDA-licensed advisors can’t sell ETFs, which are considered to be securities. Although that restriction may be lifted in 2018, according to Pat Dunwoody, executive director of CETFA, some MFDA firms have found ways to offer ETFs by forming relationships with affiliated firms that are members of the Investment Industry Regulatory Organization of Canada or with robo-advisor firms.
As well, a handful of ETF providers, including Invesco Canada Ltd. and Bank of Montreal, offer mutual funds that hold ETFs in their portfolios, thereby offering diversified exposure at reasonable fees.