Businessman on slide

In the past several years, balanced funds have gone from the most popular type of mutual fund to the most redeemed. The massive outflows coincided with the unusual phenomenon of both stocks and bonds losing money in 2022.

This market anomaly contradicted the long-held expectation among investors — and encouraged by retail brokers, fund dealers and bank-branch representatives — that diversification makes for a smoother ride and reduces the risk of significant capital loss.

In 2022, it didn’t. Most balanced mutual funds posted full-year losses in the 9%–11% range and investor disappointment resulted in net redemptions totalling $30 billion, according to the Investment Funds Institute of Canada (IFIC). Although investment performance recovered in 2023, redemptions almost doubled to $57 billion.

Contributing to the redemptions from balanced funds — and from mutual funds in general — was the “savings squeeze” experienced by Canadian households, said Carlos Cardone, senior managing director of Toronto-based Investor Economics.

Net new household savings would be about $140 billion in a normal year, Cardone said. During the Covid pandemic lockdown in 2020 and 2021, new savings swelled to $250 billion–$280 billion annually. But by 2023, net new household savings had shrunk dramatically to about $55 billion.

Cardone said the impact of the savings squeeze was felt primarily by the mass market, the investor segment that normally is the main buyer of balanced funds.

Further contributing to the shift away from long-term mutual funds in general were high interest rates and the revival of GICs as an attractive alternative for household savings. According to Investor Economics, GICs attracted a combined total of about $300 billion in new savings in 2022 and 2023.

While some of these inflows came from bank accounts that were paying much less interest than GICs were, some redemptions of investment funds found their way into GICs, Cardone said.

The future course of interest rates will continue to drive investment preferences. “When the interest-rate environment starts to normalize, you will see longer-term yields potentially becoming more attractive,” Cardone said. “We’re not yet out of the transition of the interest-rate environment.”

Expectations of rate relief later this year are being reflected in the messaging from asset managers to financial advisors during the RRSP season, he added: “You [saw] a lot of talk about locking in yield for the longer term.”

Within the broad investment-funds universe, there are significant differences in asset mix between mutual funds and ETFs. While balanced funds accounted for 47% of mutual-fund assets at the end of 2023, the fund category constituted only 4% of ETF assets, according to IFIC.

Balanced and asset-allocation ETFs haven’t gained share within the ETF industry in the past year, but have kept pace with overall asset growth. They’re a fairly recent development in the 34-year-old ETF industry in Canada, which historically has been devoted to single asset-class products.

Balanced mutual funds totalled $901 billion in assets at year-end 2023, but multi-asset ETFs held only about $16 billion, and part of that was in all-equities portfolios. Even so, asset-allocation ETFs have grown in number and in assets under management in recent years.

The current dominant provider is Vanguard Investments Canada Inc. Since 2018, Vanguard has built a suite of six asset-allocation ETFs. The five that invest in both stocks and bonds have combined assets of $8.3 billion.

A good part of the sales traction in asset-allocation ETFs comes from discount-brokerage clients, including older investors who are saving for retirement. Asset-allocation ETFs are also suitable for parents who have opened RESPs.

Cardone said many self-directed investors have embraced multi-asset ETFs as substitutes for single-exposure ETFs or direct holdings of stocks and fixed-income securities. And, because of the much lower management fees of balanced ETFs, online investors overwhelmingly favour them over balanced mutual funds.

“One of the key factors that we identified as being very positive behind these products gaining share has been the pricing,” Cardone said.

The price points of asset-allocation ETFs reflect the level of active management of the underlying holdings or tactical shifts in asset mix. At the low end, price-sensitive investors can choose from among balanced ETFs with management expense ratios of 20–25 basis points.

Cardone anticipates continued product expansion in balanced ETFs. “I’m hearing from some [fund manager] clients that maybe that’s an area where they want to plant a flag.”

The expected new competitors would join a growing number of existing multi-asset providers, which includes BlackRock Asset Management Canada Ltd., BMO Global Asset Management, CI Global Asset Management, CIBC Asset Management Inc., Fidelity Investments Canada ULC, Horizons ETFs Management (Canada) Inc., iA Clarington Investments Inc., Invesco Canada Ltd., Mackenzie Investments, Purpose Investments Inc. and TD Asset Management Inc.

ETF companies that haven’t yet expanded into multi-asset funds can take encouragement from Fidelity’s experience. The company said in early February that its four Fidelity All-in-One ETFs, launched in 2021 and 2022, continue to see positive sales momentum and recently surpassed $1 billion in assets.

This article appears in the March issue of Investment Executive. Subscribe to the print edition, read the digital edition or read the articles online.